E H HEALTH T LAWYER - americanbar.org · robyn.shapiro@ healthscienceslawgroup.com Section Delegates to the House of Delegates Christi J. Braun ... Donald H. Romano Foley & …

continued on page 3Volume 30, Number 4, April 2018

Back to the Future: Provider-Employer Alliance Direct Contracting for Health Benefits ........................ 1

Chair’s Column ........................ 2

The Price is Right? What is “Usual, Customary and Reasonable” Between Provider and Payor ................ 12

Section News ......................... 18

Impact of the Tax Cuts and Jobs Act of 2017 on Tax- Exempt Hospitals ................... 20

Extrapolating Liability – An Analysis of the Potential Use of Sampling to Establish Liability in False Claims Act Cases ........ 26

Section Calendar .......Back Cover

BACK TO THE FUTURE: PROVIDER-EMPLOYER ALLIANCE DIRECT CONTRACTING FOR HEALTH BENEFITSAlison M. Howard, Esq. Crowe & Dunlevy Oklahoma City, OK

It was the 1990s. Americans were patiently rewinding VHS tapes, belly-laughing (or cringing) at The Ren & Stimpy Show, waiting half a day for America Online to dial-up, whooping to Arsenio Hall, popping Mentos (the freshmaker), and debating the merits of East Coast vs. West Coast rap.

More importantly, perhaps, the cost of healthcare had become the most expensive in the world. The United States was spending about $4,000 per capita, more than twice the average of other developed countries.1 Then-President Bill Clinton put healthcare reform on the table, but it failed. Most people were getting their health benefits through employment, and managed care via health mainte-nance organization (“HMO”) had become the norm. This risk-bearing model, in which an insurer middleman combines healthcare delivery and financing, was designed to control cost while improving quality of care.2 But critics, providers and employers alike, were skeptical. They were not benefit-ting much from the savings, and

cost-control seemed to be compromis-ing, not improving, quality of care.3

With these concerns in mind, employers and providers explored direct contracting, i.e. excision of the middleman insurer. Rather than pay premiums to an insurer, employers con-tracted directly with providers, or more often a network of providers forming a provider sponsored organization (“PSO”), to fulfill employee healthcare needs.4 The Buyers Health Care Action Group (“BHCAG”), Minnesota’s mighty coalition of large employers, including Wells Fargo and American Express, led a particularly innovative and promising direct contracting exper-iment in the Midwest.5 And a swarm of large health system PSOs across the nation formed their own provider-sponsored health plans (“PSHPs”) to facilitate direct contracting efforts.6

But at the turn of the century, direct contracting quietly sunk back into the managed care abyss from whence it sprung. BHCAG’s ambitious regional project began losing steam in 2000, upon withdrawal of two of its largest employer members and transfer of management; ultimately it was sold to a large health plan in 2004.7 Many

TH

EHEALTHLAWYER

IN THIS ISSUE

2 The Health Lawyer Volume 30, Number 4, April 2018

Chaos and the Rule of LawChaos. Originally the Greek word meant a vast chasm, an empty void. Around 1600, the word took on the meaning we think of today, of utter confusion or disorder.1 This moment in our country feels cha-otic at the federal level. There may be motion and actions, but they seem confused and as if they are

going nowhere. This apparent dysfunction has caused me and many others frustration and increasing anxiety about the effectiveness of our system of government.

Then came the news of yet another school shooting, this time in Florida. Seventeen killed and fourteen more wounded by a disaffected young man, barely an adult, with a legally-acquired AR-15. Whatever his clinical psycholog-ical condition and whatever the source, it is easy to con-clude that he was in serious emotional pain and very angry. As has happened too many times before, our political lead-ers responded by sending thoughts and prayers, saying it was too soon to talk about remedies, and doing nothing.

But something is different this time. Students who survived the ordeal immediately stood up, said it was not too soon, and started demanding that something be done to prevent a repeat of this tragedy. They are articulate and clear, speaking their truth, calling for change. They speak with passion and commitment. And they are acting. They have gone to the Florida legislature to make their case. They planned a school walkout on March 14 and marches in Washington, DC and elsewhere on March 24.

The students are demanding changes to gun control laws and a weakening of the NRA’s influence over our law-makers. Certainly not everyone agrees with them about what should be done. But what has really struck me is the concluding message these students are delivering over and over – they are not advocating that we respond to violence with violence. They are calling on all of us to speak up for what we believe, let our representatives know what we think, and VOTE. If our representatives do not act on our behalf, vote them out and vote others in. Engage, be an active participant, and work through the American rule of law to make schools safer and the country better.

These young people both shame and inspire me. I think of times I have had strong opinions about pending legislation and did not take the few minutes to email my

Chair’s Corner

continued on page 17

Hilary H. Young

The Health Lawyer (ISSN: 0736-3443) is published by the American Bar Association Health Law Section, 321 N. Clark Street, Chicago, IL 60654-7598. Address corrections should be sent to the American Bar Association, c/o Member Records.

Requests for permission to reproduce any material from The Health Lawyer should be addressed in writing to the editor.

The opinions expressed are those of the authors and shall not be construed to represent the policies or positions of the American Bar Association and the ABA Health Law Section.

Copyright © 2018 American Bar Association.

2017-2018 Officers and Council of the ABA Health Law Section are as follows:

Young Lawyer Division LiaisonMuthuramanan Rameswaran

Arent Fox LLPWashington, DC

202/[email protected]

Law Student Division LiaisonCarpenter Marsalis

Mississippi College School of LawJackson, MS228/218-7240

[email protected]

Section DirectorSimeon Carson

American Bar Association321 N. Clark Street

Chicago, IL 60654-7598312/988-5824

[email protected]

The Health Lawyer EditorMarla Durben Hirsch

Potomac, MD 301/299-6155

[email protected]

William W. HortonJones Walker, LLPBirmingham, AL


Robyn S. ShapiroHealth Sciences Law Group LLC

Fox Point, WI414/206-2101

robyn.shapiro@ healthscienceslawgroup.com

Section Delegates to the House of Delegates

Christi J. BraunVanderbilt University

Medical CenterNashville, TN615/875-7586

[email protected]

Clay CountrymanBreazeale Sachse &

Wilson LLPBaton Rouge, LA


W. Andrew H. Gantt IIIVenable LLP

Baltimore, MD410/528-4639

[email protected]

Lisa GenecovNorton Rose Fulbright US LLP

Dallas, TX214/855-8158

lisa.genecov@nortonrose fulbright.com

Denise HannaLocke Lord LLP

Washington, DC202/220-6992

[email protected]

William HopkinsShackelford Bowen

McKinley & Norton, LLPAustin, TX


Kathy PoppittKing & Spalding LLP

Austin, TX 512/457-2004

[email protected]

Donald H. RomanoFoley & Lardner

Washington, DC202/945-6119

[email protected]

Sidney WelchHealth Law Innovation LLC

Atlanta, GA404/509-1404

[email protected]

HEALTH LAWYERT

HE

the aba health law section

Council

Immediate Past ChairC. Joyce Hall

Watkins & EagerJackson, MS


ChairHilary H. YoungJoy & Young, LLP

Austin, TX512/330-0228

[email protected]

Chair-ElectAlexandria Hien McCombs

Humana, Inc.Irving, TX


Vice ChairJohn H. McEniry IV

Consors ConsultingFairhope, AL205/427-2443

[email protected]

SecretaryHal Katz

Husch Blackwell LLPAustin, TX


Budget OfficerEugene M. Holmes

The Walt Disney CompanyBurbank, CA818/560-2611

[email protected]

Budget Officer-ElectAdrienne Dresevic

The Health Law PartnersSouthfield, MI 248/996-8510

[email protected]

1 Online Etymology Dictionary, www.etymonline.com/word/chaos.

3Volume 30, Number 4, April 2018 The Health Lawyer

continued on page 4

of these PSHPs failed.8 They were unable to gain sufficient share within their local markets to compete with national insurance companies. Or there was irreconcilable conflict between payor and provider values (the former over the latter favoring lower reim-bursement and/or utilization rates). Or enrollment did not increase quickly or substantially enough to offset capital investment in administration and regu-latory compliance, making it difficult to achieve economies of scale.9

Fast forward a couple of decades. Healthcare in the United States, which now spends over $10,000 per capita, is still the priciest in the world, by a large margin.10 Reform again is on the table, with then-President Barak Obama’s Patient Protection and Affordable Care Act (“PPACA”) tak-ing some punches from the Trump administration. Over 150 million Americans get their health coverage through employment.11 National insurance companies still rule the sea. And providers and employers wonder again if they might do a better job navigating cost and quality care. Large employers like Boeing, Intel, and Walmart are teaming up with PSOs.12 Indeed, Amazon, Berkshire Hathaway, and J.P. Morgan are forming a health-care purchasing employer consortium in the image of BHCAG.13 Even small employers are gaining interest in direct contracting, as self-funding pro-tected by stop loss group captive cov-erage becomes more common; healthcare reforms aimed at increasing the purchasing power of small employ-ers, e.g. by expanding access to associ-ation health plans (“AHPs”), may provide further incentive.14 Direct contracting is resurfacing.

Direct Contracting ModelDirect contracting involves a con-

tract for healthcare services offered by a PSO directly to an employer or

group of employers.15 Under the tradi-tional, i.e. indirect model, a state-regu-lated health insurance company or organization, such as an HMO or pre-ferred provider organization (“PPO”), acts as intermediary between provider and employer in managing the deliv-ery and financing of healthcare. The insurer contracts with a set of provid-ers to form a network that delivers care at preferred pricing. The insurer then “rents” this network to the employers with which it contracts to make available under the employer’s health benefit plan. The insurer in the middle is responsible for coordi-nating the delivery of services by pro-viders with the payment for these services under employee benefit plans.16 While this model lifts the burden of healthcare management from the provider and employer and places it on the shoulders of the insurer, it also restricts the ability of the provider and employer to control cost and quality of care.

The direct contracting model purports to bypass the insurer. It brings the medical professionals pro-viding the care face-to-face with the employers and employees paying for the care, through a direct contract between the PSO and employers sponsoring self-funded employee ben-efit plans. A PSO, which is a broad and flexible concept, can take a variety of forms, including a physician group practice, a joint venture network such as an independent practice association (“IPA”) or physician hospital organiza-tion (“PHO”), an integrated health care network, an accountable care organization (“ACO”), or a health plan owned or controlled by providers (PSHP).17 In many instances, a PSO starts out as a health system self-fund-ing its own employee benefit plan and those of its affiliates. Having gained experience juggling the delivery and financing of care, it might expand to contract with unaffiliated employers

or even obtain certification as a PSHP so as to underwrite insurance and take on 100 percent of the risk and savings.18 In the most basic sense, a PSO is a healthcare delivery system or plan managed by providers.19 A PSO often forms its own network(s), which it takes directly to employers to make available under the employ-ers’ health plans at preferred pricing.

Typically the PSO assumes some kind of financial risk that its services will be utilized above anticipated lev-els of reimbursement, even if it is not a health plan. Risk-sharing arrange-ments between PSOs and payors can take the form of capitation, fee-for-ser-vices with substantial withhold, a per-centage of premium paid, or bonuses/penalties associated with meeting cost/utilization goals.20 As such, the line between provider and payor becomes blurred, and, depending upon the amount of risk assumed, the PSO arguably replaces, rather than elimi-nates, the insurer.21 The PSO also assumes the insurer’s role in managing administration of reimbursement for its services and typically subcontracts with a third-party administrator in this regard to assist with claims pro-cessing, population health manage-ment, and health plan participant onboarding.

The PSO of today is not much different from its younger nineties self, but the environs may be more welcoming. The basis of healthcare reimbursement no longer is moored in fee-for-service. Healthcare reform ini-tiatives, including PPACA, have firmly shifted the focus to value; reim-bursement is tied to quality and effi-ciency. And one may ask, who better to manage cost-effective and quality care than the provider actually deliv-ering it? It’s certainly easier for the provider to do so now than 20 years ago, given that continuous quality improvement seems to be replacing utilization review and physician

Back to the Future: Provider-Employer Alliance Direct Contractingcontinued from page 1



profiling as the method of choice to measure value. Providers have at their fingertips performance management and population health-tracking tools, such as electronic data transparency, pay-for-performance standards, and care coordination.22 This new focus on and approach to value marries well with the narrow network concept, which PSOs employ to control qual-ity and cost by restricting consumer choice to a range of providers offering services at reduced rates.23

Further, recent reform measures may help cultivate direct contracting for small employers. One such mea-sure, as noted above, would expand access to AHPs. An AHP allows cer-tain employers to band together to provide health coverage to employees as a single “employer” unit. An AHP can give small employers the advan-tages and purchasing power of a large employer, which spreads risk and administrative cost across a bigger pool. Moreover, an AHP can attain sufficient size to qualify for large group health coverage, which is less regu-lated than individual and small group coverage under PPACA. In January 2018, in response to an Executive Order, the U.S. Department of Labor (“DOL”) proposed a rule that purports to allow more employers to form AHPs, in particular by dispensing with the requirement that the employer association have a purpose other than offering health coverage and by expanding the commonality of interest requirement to employers (a) in the same trade/industry or (b) within the same geographic area.24

Benefits and RisksDirect contracting has some posi-

tive features. It purports to give employers more control over the way in which they spend healthcare dollars, improve access to high-quality care at affordable and more transparent cost, increase provider accountability through provider risk-bearing, and

encourage competition and choice in the healthcare market.25

The collaboration between Intel Corp. and Presbyterian Healthcare Services in New Mexico is an exam-ple of a direct contracting success story. The IT giant and New Mexico’s largest healthcare system teamed up to create Connected Care to finance and deliver services to Intel’s 3,500 employees (and 10,000 dependents) at Intel’s semiconductor manufactur-ing plant in Albuquerque. The pro-gram’s provider reimbursement model is value-based, incorporating shared-risk and pay-for-performance stan-dards. To promote evidence-based treatment of chronic conditions, the program covers 100 percent of the cost of preventive care and prescription drugs for such conditions as asthma, hypertension, and diabetes. The suc-cess of Connected Care lies in large part with the managed care experience of its PSO, Presbyterian Healthcare Services, which owns its own health plan and invested significantly in IT to coordinate care. Intel expanded its Connected Care model to other states where it has large workforces, includ-ing collaborations with Providence Health Services in Oregon and Ari-zona Care Network in Arizona.26

Direct contracting also has poten-tial drawbacks. Providers may under-estimate the risk involved in earning an acceptable return, given the mar-gin discounts employers often require and the complexity involved in mar-keting and maintaining a care man-agement system that competitively delivers on the value proposition of high quality care at lower cost. Achiev-ing this goal is challenging on its own; it becomes even more difficult when pursued alongside other provider initia-tives, such as clinical integration and population health improvement.27 Smaller provider groups are at a par-ticular disadvantage, since a success-ful direct contracting model requires access to comprehensive care and

sufficient capital to achieve econo-mies of scale.28 Employers, in turn, may overestimate the potential for savings and/or have unrealistic expec-tations as to results. Intel’s winning direct contracting design was forged by unique circumstances and is not easily replicated.29

Significantly, both providers and employers may not fully appreciate the risk to the enrollee/consumer that particular healthcare needs will not be covered, that coverage will not be affordable or that affordable coverage will compromise quality or the enroll-ee’s choice of provider, and that cover-age will be lost altogether due to payor/plan insolvency. An arsenal of state and federal law is aimed at protecting the consumer against this risk. More-over, traditionally the insurer mans it.

In direct contracting, this admin-istrative and regulatory responsibility is left to the PSO providers and employers. They need to ensure pre-mium collection, claim payment, fraud investigation, case manage-ment, cost containment, continua-tion coverage, protection of personal health information, physician creden-tialing and quality monitoring, non-discrimination in benefits, and more. Further, addressed more fully below, the direct contracting arrangement may need to comply with state laws requiring registration and capital reserve, mandating certain benefits, and restricting preferred provider arrangements and balance billing. None of this is easy, inconsequential work. It takes time and money, which has a habit of running out.

These kinds of risks materialized for direct contractors in the 1990s, as noted above, and they remain a con-cern today, if the Robert Wood John-son Foundation report card on the recent generation of health plan PSOs is any indication. Since 2010, 42 health systems formed health plans (PSHPs). Only four were profitable by 2015, and five went out of business.


continued on page 6

The rest were operating at a loss, some bleeding significantly.30 Why are these PSO plans failing? “Few new plans have gained enough enrollees to achieve economies of scale in plan administration, to gain ability to man-age risk, or to have an impact on competition and price in their local markets.”31 In pursuing the strategy of delivering high quality care at a lower cost, those PSO plans still alive have been keeping costs down, not through reduced utilization or better care man-agement, but by paying their own pro-viders below-market rates. This is not sustainable.32 And these are the PSOs that had the capital and large market presence to become licensed insurance plans. The prospects for smaller, less organized PSO direct contracting arrangements may be even dimmer.

But there’s always a new horizon.

Legal IssuesThere are, as noted, myriad state

and federal laws protective of health-care consumers potentially implicated by directed contracting arrangements. This article focuses on those that raise legal issues meriting the particu-lar attention of providers and employ-ers considering a maiden voyage into direct contracting without a health plan (PSHP) and/or with multiple employers. First, a PSO in a typical direct contracting relationship takes on some level of risk, opening the door to state regulation akin to an insurance company or pursuant to laws in some states already in place to regulate PSOs. Second, a PSO con-tracting with multiple employers arguably gives life to a creature known as a multiple employer welfare arrangement (“MEWA”), which is heavily regulated by both state and federal law. Third, a PSO in a typical direct contracting relationship likely qualifies as a fiduciary under the Employee Retirement Income Secu-rity Act, 29 U.S.C. §§ 1001 et seq. (“ERISA”), subject to federal regu-lation as such. Finally, a PSO

attempting to market a direct con-tract to employers should be mindful of antitrust law restrictions on collec-tive fee negotiation.

Insurance

Even jettisoning the traditional middleman insurer, the typical PSO in a direct contracting arrangement itself may be engaged in the business of insurance. A PSO accepts financial risk that enrollees will be covered for services in amounts beyond those paid. This risk often takes the form of capitation, i.e. reimbursement capped at a prepaid amount (premium). But PSO providers also assume risk when reimbursement is based upon a per-centage of premium paid or even when services are provided on a fee-for-service basis where there is sub-stantial withhold or application of bonuses and/or penalties based upon satisfaction of cost/utilization goals.33 Assumption of risk is a murky con-cept, but it is an essential element of the business of insurance, potentially triggering state regulation.34

State regulators were faced with the questions of whether and how to regulate PSOs and direct contracting relationships in the 1990s. Most took the view that PSOs assuming substan-tial risk, such as via capitation, are in the business of insurance and should be regulated as such.35 Their view was supported by the National Associa-tion of Insurance Commissioners (“NAIC”), which was developing a functional approach to regulation that would apply the same standards to all entities bearing risk, regardless of the form of the entity.36 Most states approached PSO regulation through HMO statutes already on the books. HMOs typically must be licensed, make available large reserve funds, pay premium taxes, provide certain mandated benefits, and satisfy rating standards. Some states enacted legis-lation specifically targeting PSOs, focused mostly on solvency protec-tion and not meaningfully different from HMO legislation.37

However, states were shy to enforce the regulation of PSOs and direct contracting. The concept of a PSO was foreign and elusive. It was not just a group of providers offering healthcare, but it was not quite an HMO monolithically geared toward risk management. While it was clear a typical PSO in a direct contracting relationship assumed some kind of risk, it was not clear which ones did or to what extent. Moreover, there was, and still is, a good deal of ambiguity sur-rounding the concept of the business of insurance, in particular as to the nature and degree of risk transfer involved. Further, state regulators struggled with the competing purposes of insur-ance regulation to (a) protect the consumer and (b) facilitate a level playing field in the health insurance marketplace.38 Consumer protection concerns demand oversight of risk-bearing entities, in particular to ensure solvency. That the risk-bearing entity is run by medical providers does not eliminate these concerns; arguably it heightens them, given that managed care is not the bailiwick of the typical medical provider. On the other hand, regulators are loathe to stifle innova-tion in competition, especially in the face of healthcare cost crises. Burden-ing PSOs with time-consuming and expensive regulatory requirements cre-ates a barrier to entry in the market.39

To make matters more compli-cated, it was, and still is, not clear to what extent state regulation of direct contracting involving “self-funded” employee benefit plans is preempted by ERISA, and therefore inapplicable to arrangements with these plans.40 A self-funded plan is one that is not funded through an insurance con-tract. There is a general understand-ing that state insurance laws that relate to an employee benefit plan gov-erned by ERISA41 are saved from fed-eral preemption, and apply with respect to a fully-insured plan but not as to a self-funded plan. More pre-cisely, by virtue of ERISA’s “deemer clause,” state insurance law of general



application that relates to an employee benefit plan is preempted to the extent it purports to regulate the employee benefit plan itself, as opposed to the insurance arrangement funding it.42 For example, the insurance arrange-ment funding an insured plan is sub-ject to a state’s mandated benefits law; but if the ERISA plan is not funded by an insurance arrangement, i.e. is self-funded, the plan would not be subject to the state law mandating coverage of certain benefits.

ERISA does not necessarily pro-tect a PSO or its direct contracting relationship with an employer from state regulation merely because the arrangement serves a “self-funded” ERISA-governed employee benefit plan. While ERISA may preempt reg-ulation of the employee benefit plan itself, it does not preempt regulation of the entity with which the plan does business or the insurance terms thereon. The real question is whether the direct contract between the PSO and employer constitutes the business of insurance. Stated otherwise, an employee benefit plan that is funded by a PSO contract that is deemed an insurance contract is not really “self-funded” in the first place for purposes of the ERISA preemption analysis.

When regulators were struggling with these issues back in the 1990s, an employer group advocating for looser regulation of PSOs argued that a direct contract involving a self-funded plan is not the business of insurance because the employer with which the PSO contracts, which is not itself in the business of insurance, is capable of managing risk on behalf of its employ-ees and that the risk it transfers to the PSO is not supported by actuarial assessment or hard cash, as with risk assumed by an HMO.43 But, given that employers – even large, orga-nized, financially-sound ones – enter into contracts with HMOs to fund “insured” plans that unquestionably constitute the business of insurance

for purposes of ERISA, this argument seems reduced to the proposition that PSO contracts do not constitute the business of insurance because PSOs are not as savvy or solvent as HMOs at conducting that business.

If there is a transfer of substantial risk to the PSO such as via capita-tion, whether or not the employer also bears some risk and regardless of how (well) the PSO measures and manages it, it smells like the business of insurance for purposes of state reg-ulation saved from ERISA preemp-tion. This was the position of the NAIC and the understanding of most of the states that had explored the issue in the 1990s.44 To be sure, there may be ways to structure shared risk under a direct contract to avoid clas-sification as the business of insurance that merit exploration. But a PSO and employer considering direct con-tracting would be wise not to assume state insurance law is inapplicable merely because the employee benefit plan is governed by ERISA and his-torically has been self-funded. Playing around with insurance may raise more than the ire of state regulators. Absent ERISA preemption, an insur-ing entity is exposed in many states to bad faith tort liability and extra-con-tractual and punitive damages for improper claims handling.45

States have yet to take a clear stance on the regulation of direct contracting. Some may forego regula-tion altogether or take a laissez-faire approach to enforcement. But an unlicensed PSO and its risk-sharing employer partner may be treading on thin ice in other states. One com-mentator suggests that most PSO direct contracting arrangements cur-rently are illegal, at least under some states’ law.46 Unless and until regula-tors and/or legislation provide clarifi-cation, the safest approach, or the one that might best suit the risk-averse PSO and employer with direct contracting designs, is to either (a)

enter into a no-risk arrangement, e.g. by contracting for reimbursement strictly on a fee-for-service basis with-out substantial withhold or bonuses/penalties; or (b) comply with state laws applicable to HMOs or PSOs.

MEWAs

A PSO direct contract ing arrangement with multiple employers may be subject to even stricter regula-tion under state law than the single-employer variety, if the arrangement is allowed at all. Many states regulate MEWAs. The fact that all of the employers participating in the arrangement sponsor “self-funded” employee benefit plans does not avoid MEWA status or state regulation.

A MEWA is easily formed, some-times inadvertently or without all members’ knowledge. It is simply an arrangement established or main-tained for the purpose of providing benefits, such as healthcare benefits, to the employees of multiple employ-ers.47 Only multiple employers within the same control group of companies constitute a single employer for pur-poses of assessing whether an arrange-ment constitutes a MEWA, and only an arrangement that is established or maintained under a collective bar-gaining agreement or by a rural elec-tric or telephone cooperative is exempt from MEWA status.48 Other-wise, any combination of employers in an arrangement aimed at providing health benefits forms a MEWA.

An arrangement need not itself qualify as an “employee welfare bene-fit plan” within the meaning of ERISA or be sponsored by an “employer” to be a MEWA.49 In other words, a MEWA can be sponsored by a third party for the benefit of employ-ees of employer members that have their own separate employee benefit plans. For example, an arrangement maintained by a banking association that benefits the employees of the employer bank members of the


association, plus banking customers, is a MEWA that is not an “employee welfare benefit plan” since benefits are extended beyond bank employees to non-employee banking customers. The employee benefit plans of each employer member individually are governed by ERISA, but the MEWA itself is not.

Some MEWAs are themselves “employee welfare benefit plans” within the meaning of ERISA. An “employee welfare benefit plan” is a plan, fund, or program established or maintained by an “employer” or “employee organization”50 or both for the purpose of providing benefits such as health benefits to its “participants.”51 A “participant” of an employer plan means a current or former employee.52 Because ERISA defines an “employer” to include a “group or association of employers,” a MEWA established or maintained by the same for its employ-ees constitutes an “employee welfare benefit plan.”53 Not many multiple employer groups qualify as “employee welfare benefit plans” under the DOL’s current narrow interpretation of the term “group or association of employ-ers.” That is expected to change with the DOL’s proposed rule expanding access to AHPs, but the application of state law to MEWAs that are ERISA plans is not.54

All MEWAs, regardless of whether they are ERISA plans, are subject to regulation under state law to some extent. A MEWA that is not itself an ERISA plan is subject to the full array of state regulation applica-ble to MEWAs. A MEWA that is an ERISA plan is subject to a degree of state regulation, depending upon whether the plan is fully-insured or self-funded, the latter generally being more heavily regulated, sometimes effectively out of existence.

As explained above, ERISA’s deemer clause generally has the effect of protecting employee benefit plans themselves from state regulation oth-erwise saved from preemption.55

However, ERISA was amended in 1983 to provide an exception to ERISA’s preemption provisions for MEWAs.56 The exception essentially allows states to regulate MEWAs as insurance companies.57 “The impetus behind the amendment was an inter-est in curbing abuses by multiple employer trusts, which would claim ERISA preemption when states attempted to regulate them as quasi-insurance companies.”58 Congress was particularly concerned with self-funded MEWAs. “After thwarting state regulation, some of these unin-sured trusts declared bankruptcy, leav-ing employees responsible for millions of dollars in unpaid hospital and medi-cal bills.”59 “The MEWA amendment’s sponsor viewed uninsured MEWAs as thinly disguised insurance arrange-ments that properly should be regu-lated at the state level.”60

Accordingly, even if a MEWA is a self-funded ERISA plan, states may apply and enforce their insurance laws with respect to the plan pretty much to the same extent as with respect to an insurance company or plan not governed by ERISA, as long as the law is not inconsistent with ERISA. Thus, states may regulate solvency, benefit levels, or rating of a self-funded ERISA-governed MEWA and require registration and claims data reporting of MEWA operators. Fully-insured MEWAs that are ERISA plans are subject to state laws that regulate the maintenance of specified contri-bution and reserve levels, and the insurance arrangement supporting the plan is subject to state insurance laws of general application saved from ERISA preemption, e.g. requiring reg-istration, certain reserves, and/or man-dated benefits.61

States’ approaches to MEWA reg-ulation vary. A small number of states do not appear to regulate MEWAs at all or do so only through legislation aimed at facilitating small employer AHP coverage.62 Many states do not regulate fully-insured MEWAs, except

through regulation of the insurer funding it. But most states regulate self-funded MEWAs in some way, shape, or form, including by requiring registration, certain reserve levels, maintenance by an entity legally existing for a number of years, and/or control by a board of trustees.63 Some states require that self-funded MEWA agreements include terms making par-ticipating employers responsible to pay for losses or deficits realized by the MEWA. Arguably, the way most states regulate self-funded MEWAs essentially prohibits them from exist-ing as such (self-funded), by deeming MEWAs not funded by an insurance contract unauthorized insurers and/or requiring them to satisfy requirements akin to an insurance company.64

MEWAs that are ERISA plans are also subject to federal regulation. A MEWA plan must file a detailed report (Form M-1) and register with the DOL prior to operating in a state. Further, PPACA introduced enforce-ment measures to combat MEWA fraud and abuse. The DOL now can issue a summary seizure order to a MEWA that is in a financially hazard-ous condition65 or an ex parte cease and desist order to a MEWA that engages in conduct that is fraudulent, creates an immediate danger to the public safety or welfare, or is causing or reasonably can be expected to cause significant, imminent, and irreparable public injury.66 Moreover, a MEWA that makes false statements in connection with sales or marketing is exposed to criminal penalties.67 Fur-ther, as set forth more fully below, the operator of a MEWA that is not an ERISA plan is subject to federal regu-lation to the extent the operator qualifies as a fiduciary of the employee benefit plans participating in the arrangement.

Many PSO arrangements involv-ing multiple employers unrelated by common ownership likely qualify as MEWAs under current law. A typical PSO direct contracting arrangement

continued on page 8



exists for the singular purpose of pro-viding healthcare benefits to employ-ees of the employers with which the PSO contracts. Thus, an arrangement is a MEWA to the extent that it involves more than one employer not within the same control group, and is not maintained under a collective bargaining agreement or by a rural telephone or electric cooperative. If the PSO MEWA is not established or maintained by a bona fide employer group or association within the mean-ing of ERISA or is not maintained solely for employees (and their depen-dents), it is not an employee benefit plan governed and protected by ERISA. In that event, state law gov-erning MEWAs applies without limita-tion. But even if the PSO MEWA qualifies as an ERISA plan, it is subject to state law. If the direct contract involves self-funded plans and does not constitute the business of insur-ance, the ERISA PSO MEWA is sub-ject to extensive regulation, or even prohibition, in some states. If the direct contract is deemed the business of insurance, the ERISA PSO MEWA may avoid state law applicable to self-funded MEWAs but would need to comply with any state law requiring a fully-insured MEWA to maintain spec-ified contribution and reserve levels.

The fact that a direct contracting arrangement involves an AHP does not, as yet, avoid MEWA status or strictures. An AHP is a type of MEWA and is subject to regulation as such. The recently proposed DOL rule expands access to AHPs, but, as the DOL confirms, the proposed rule “would not alter existing ERISA stat-utory provisions governing MEWAs” and “would not modify the States’ authority to regulate health insurance issuers or the insurance policies they sell to AHPs.”68 If the PSO is deemed an insurer due to risk assumption and is deemed to exercise control over the direct contracting arrangement, the AHP may not be allowable at all,

given that an AHP cannot be “owned or controlled” by a health insurer.69 Otherwise, if the PSO AHP consti-tutes a self-funded ERISA plan, it is subject to the same broad state regu-lation applicable to other self-funded MEWAs, unless and until the DOL exercises its authority to exempt cer-tain self-funded MEWAs from state regulation. Thus far the DOL has not exercised this authority, although it has solicited input about potential exemptions in this regard for self-funded AHPs.

Accordingly, a direct contracting arrangement involving multiple employers raises more than state insurance law concerns. Providers and employers considering a foray into direct contracting might explore struc-turing such an arrangement in a way that avoids or minimizes the burdens typically associated with MEWA status.

ERISA

A PSO direct contracting arrange-ment implicates ERISA, whether or not the arrangement itself is an “employee welfare benefit plan” within the meaning of ERISA. If the arrange-ment itself qualifies as an ERISA plan, i.e. is established or maintained by an employer or bona fide group or associ-ation of employers or an employee organization, it is subject to all of the ERISA rules and regulations govern-ing employee benefit plans. ERISA plans must be maintained pursuant to their written terms and in accordance with certain fiduciary standards, dis-close certain information to partici-pants and the DOL, and provide certain claims procedure and adminis-trative review.70

Even if the direct contracting arrangement is not an ERISA plan, the PSO operating the plan likely qualifies as a fiduciary subject to ERISA’s fiduciary standards. Invariably, some, if not most, of the employee benefit plans benefitting from the direct contracting arrangement that

their sponsoring employers enter into with the PSO are governed by ERISA. As the DOL explains, when the spon-sor of an ERISA-covered plan pur-chases healthcare coverage for its employees in such an arrangement, the entity managing or operating the arrangement typically becomes a fidu-ciary of the plan subject to ERISA’s fiduciary requirements.71

A “fiduciary” of an employee ben-efit plan, within the meaning of ERISA, includes any person who “exercises any discretionary authority or discretionary control respecting management of such plan or exercises any authority or control respecting management or disposition of its assets,” or any person who “has any discretionary authority or discretion-ary responsibility in the administra-tion of such plan.”72 Setting plan network reimbursement terms and directly collecting reimbursement from the plan pursuant to those terms would seem to qualify as “control respecting management or disposition of [plan] assets.” The plan’s delegation of any administrative authority over the plan’s network benefits to the PSO would seem to imbue the PSO with “discretionary control respecting management” of the plan.

ERISA establishes uniform min-imum standards to ensure the fair and fiscally sound management of employee benefit plans. Plan fiducia-ries must operate a plan for the exclu-sive benefit of participants, comply with “prudent man” requirements, refrain from conflicts of interest and prohibited transactions, and fund and administer benefits consistently with the law and the plan.73 A fiduciary is liable not only for breach of its own responsibilities but for breach of a co-fiduciary’s responsibilities if the fidu-ciary knowingly participates in the breach or if the fiduciary’s failure to fulfill its own duties enables the co-fiduciary’s breach.74 Liability exposes a fiduciary, and anyone who knowingly


participates in the breach, to signifi-cant civil penalties.75

One commentator raises con-cerns as to the ability of a PSO to sat-isfy ERISA’s fiduciary standards, since the typical PSO wears two hats - pro-vider/biller and payor.76 It provides and bills for the network healthcare services. It also bears the financial risk of a payor to the extent it accepts reimbursement that is capitated, fee-for-service with substantial withhold, a percentage of premium, or subject to bonus/penalty tied to cost/utiliza-tion goals. The PSO should take care not to let this dual role create conflict contrary to ERISA’s requirement of fiduciary independence.

Antitrust

Providers entering the direct con-tracting field additionally will want to avoid antitrust landmines. The provid-ers in a PSO network ideally will col-lectively negotiate fee arrangements when contracting directly with employers. The collective negotiation of fees by physicians and hospitals that otherwise are competitors implicates price-fixing concerns under federal and state antitrust laws. Collective fee negotiation by a network of providers is permissible if the network is sufficiently integrated, e.g. the providers in the network share substantial financial risk or are clinically integrated so as to gen-erate significant efficiency and make joint pricing reasonably necessary.77

A non-integrated network may not collectively negotiate fees or other economic terms. The providers in a non-integrated network may still take a coordinated approach to direct contracting, via a messenger model, but that approach risks running afoul of antitrust laws if it facilitates agree-ments among providers on the prices to accept from employers.78 In a mes-senger model, a third party, the mes-senger, coordinates the exchange of proposed payment terms between payor and providers. It is key to the legality of this approach that each provider decide independently whether to accept or reject payment

terms. The Federal Trade Commission (“FTC”) is wary of anything that looks like collective decision-making in assessing whether an arrangement improperly facilitates an agreement among competitors on price. To be sure, a PSO has the option of obtain-ing an FTC Advisory Opinion as to the propriety of its network for pur-poses of collective negotiation or messenger model contracting.79

ConclusionAs in the 1990s, direct contract-

ing between providers and employers offers a promising alternative to the current insurer-managed healthcare network model in terms of addressing concerns regarding cost transparency and affordable, quality care. However, providers and employers would do well to do their research into the business and legal risks and require-ments of such an enterprise before dropping the middleman insurer. His-tory teaches that direct contracting is fertile but rocky ground.

Alison M. Howard is chair of the Employee Benefits & ERISA Practice Group at Crowe & Dunlevy, a regional law firm based in

Oklahoma for more than a century. Ms. Howard concentrates her practice on healthcare and employee benefits law, and also handles complex civil litigation and appeals. She received her Juris Doctor from Notre Dame Law School and her bachelor’s degree in English and pre-medicine from the University of Notre Dame. She may be reached at (405) 239-6675 or alison.howard@ crowedunlevy.com.

The foregoing should not be understood as, or considered a substitute for, legal advice. For specific inquiries, please contact Ms. Howard or another licensed attorney.

Endnotes1 Barbara C. Colombo & Robert P. Webber,

Regu la t ing R i sk in a Managed Care

Environment: Theory vs. Practice, The Minne-sota Experience, 8 AnnAls HeAltH l. 147, 152 (1999).

2 Id. at 150-51.3 Id. at 151-52.4 Id. at 160.5 Jon B. Christianson & Roger Feldman, Export-

ing the Buyers Health Care Action Group Pur-chasing Model: Lessons from Other Communities, 83 MilbAnk Q. 149, 149-50 (Mar. 2005).

6 GunjAn kHAnnA, PHd et Al., Mckinsey & co., Provider-led HeAltH PlAns: tHe next Frontier – or tHe 1990s All over AGAin? (2015); Julie A. Simer & J. Scott Schoeffel, The Wide World of Narrow Networks: How Health Care Providers Can Adapt and Succeed, 9 J. HeAltH & liFe sci. l. 9, 27 (Oct. 2015).

7 Christianson & Feldman, supra note 5, at 149-176.

8 Alice Gosfield, Provider-Sponsored Health Plans, 2017 HeAltH l. HAndbook 9 (May 2017).

9 kHAnnA et Al., supra note 6; AllAn bAuMGArten, robert Wood joHnson FoundAtion, AnAlysis oF inteGrAted delivery systeMs And neW Provider-sPonsored HeAltH PlAns (June 2017).

10 brAdley sAWyer & cyntHiA cox, tHe Henry j. kAiser FAMily FoundAtion, HoW does HeAltH sPendinG in tHe u.s. coM-PAre to otHer countries? (Feb. 13, 2018); Ricardo Alonso-Zaldivar, $10,345 per person: U.S. health care spending reaches new peak, Pbs neWs Hour, July 13, 2016.

11 tHe Henry j. kAiser FAMily FoundAtion, 2017 eMPloyer HeAltH beneFits survey (Sept. 19, 2017).

12 William T. Eggbeer et al., Next Generation Healthcare: Employer-led innovations for health-care delivery and payment reform, HeAltH cAre FinAnciAl MGMt. Ass’n, March 2016.

13 Glenn Luk, Quora, Amazon, Berkshire Hatha-way, and JP Morgan Are Forming A Healthcare Mega-Company, Forbes, Feb. 16, 2018.

14 Eggbeer et al., supra note 12; Michael Schro-eder, Small to Midsized Employers are Now Contracting Directly with Healthcare Providers, cHieF executive, Oct. 25, 2016.

15 Colombo & Webber, supra note 1, at 160.16 Id.17 Douglas J. Witten, Regulation of “Downstream”

and Direct Risk Contracting by Health Care Pro-viders: The Quest for Consumer Protection and a Level Playing Field, 23 AM. J.L. & MED. 449 at 452 (1997); Edward B. Hirshfeld, J.D. et al., Structuring Provider-Sponsored Organiza-tions: The Legal and Regulatory Hurdles, 20 j. leGAl Med. 297 at 308-309 (Sept 1999).

18 John Chesley et al., Blurring The Line Between Health Care Provider And Payor, Law 360, Sept. 20, 2017; George Lynn, The Financial Advantages of Provider-Sponsored Health Plans, HeAltHcAre FinAnciAl MGMt. Ass’n, May 4, 2015.

19 Hirshfeld et al., supra note 17, at 308. Because the concept of a PSO is so broad and indefi-nite and many may operate without any iden-tifying state certification or for only a short period of time, it is difficult to capture the number of PSOs in existence. With respect to




PSHPs, which are PSOs licensed as health plans, by 2017 there were over 100 health sys-tems certified as such. Gosfield, supra note 8; bAuMGArten, supra note 9.

20 Hirshfeld et al., supra note 17, at 308; see also Colombo & Webber, supra note 1, at 160; Witten, supra note 17, at 454.

21 Witten, supra note 17, at 453-455; Christopher B. Thurman, The Risk of Shared Savings in the Commercial Insurance Market, 52 u. louisville l. rev. 559 at 573 (2014).

22 Gosfield, supra note 8; kHAnnA et Al, supra note 6; vAlence HeAltH, Provider-sPonsored HeAltH PlAns: tHe ultiMAte vAlue-bAsed HeAltHcAre PlAn (2015).

23 Simer & Schoeffel, supra note 6, at 13-14; Valence Health, supra note 22.

24 Definition of “Employer” Under Section 3(5) of ERISA-Association Health Plans, 83 Fed. Reg. 614 (proposed Jan. 5, 2018) (to be codified at 29 C.F.R. § 2510).

25 Eggbeer et al., supra note 12; Colombo & Webber, supra note 1, at 160-61; Hirshfeld et al., supra note 17, at 297-98.

26 Eggbeer et al., supra note 12.27 Id.; see also kHAnnA et Al., supra note 6;

bAuMGArten, supra note 9. 28 Colombo & Webber, supra note 1, at 161.29 Eggbeer et al., supra note 12. Intel is a very large

employer, sometimes the largest in a metropoli-tan area, with a nationwide presence, deep capital resources, and established partnerships with large health systems across the country.

30 bAuMGArten, supra note 9. 31 Id.32 Id.33 Thurman, supra note 21, at 573-74; Colombo

& Webber, supra note 1, at 154-55; Hirshfeld et al., supra note 17, at 309.

34 As made clear by the McCarran-Ferguson Act, states have primary jurisdiction to regulate the business of insurance. 15 U.S.C. § 6701. The U.S. Supreme Court set forth three non-deter-minative characteristics of an activity that tends to constitute the business of insurance: (1) spreading of risk, (2) integral part of the insurer-insured relationship, and (3) limited to entities within the insurance industry. Metro. Life Ins. Co. v. Mass. 471 U.S. 724 (1985).

35 Witten, supra note 17, at 468; Hirshfeld et al., supra note 17, at 312.

36 Witten, supra note 17, at 476-79.37 Hirshfeld et al., supra note 17, at 353 (summariz-

ing PSO legislation in Georgia, Iowa, Kentucky, Minnesota, New York, Ohio, Oklahoma, and Texas); see also Witten, supra note 17, at 471-74.

38 Witten, supra note 17, at 458.39 Hirshfeld et al., supra note 17, at 310; Witten,

supra note 17, at 479-81. 40 Witten, supra note 17, at 462-64.41 An “employee benefit plan” within the meaning

of ERISA is broadly defined as any plan, fund, or

program that is established or maintained by an employer or employee organization for the pur-pose of providing benefits to employees. 29 U.S.C § 1002(1). Such plan is governed by ERISA, unless it is one of a few plans exempted from ERISA, e.g. a “church plan” or “govern-mental plan.” 29 U.S.C § 1003(a)-(b),

42 29 U.S.C. § 1144(b)(2)(B). The combined effect of ERISA’s savings and deemer clauses is “to allow state insurance regulation of general application, while forbidding a state from applying such regulation to ERISA plans directly.” Fuller v. Norton, 86 F.3d 1016, 1023-1024 (10th Cir. 1996) (citing FMC Corp. v. Holliday, 498 U.S. 52 (1996), at 61).

43 Witten, supra note 17, at 480-81.44 Id. at 478-79 (citing risk-beArinG entitites

WorkinG GrP., nAt’l Ass’n oF ins. coMM’rs, tHe reGulAtion oF HeAltH risk-beArinG entities, 26 (1996)). Of the states surveyed in 1994, 25 took the position that they would reg-ulate a PSO even if the direct contracting rela-tionship was with a self-funded ERISA plan; 23 had not yet addressed the issue. Hirshfeld et al., supra note 17, at 314 (citing Ernst & Young LLLP, Physician Hospital Organizations: State Regulators Play Catch-Up 4 (1994)).

45 internAt’l Ass’n. oF deF. counsel, insur. And reinsur. coMM., 50 stAte insurAnce And bAd FAitH Quick reFerence Guide (2014).

46 Frederick D. Hunt, Jr., Most* Medical Provider Network Entities that Contract Directly with Employers are Currently Illegal, beneFitslink, 2018, https://benefitslink.com/articles/providers.html.

47 29 U.S.C. § 1002(40).48 Id.49 See u.s. deP’t oF lAbor, MultiPle eMPloyer

WelFAre ArrAnGeMents under tHe eMPloyee retireMent incoMe security Act: A Guide to FederAl And stAte reGulAtion at 19, 24 (Feb. 2013).

50 An “employee organization” is “any labor union or any organization of any kind, or any agency or employee representation committee, association, group, or plan, in which employees participate and which exists for the purpose, in whole or in part, of dealing with employers concerning an employee benefit plan, or other matters incidental to employment relation-ships; or any employees’ beneficiary association organized for the purpose in whole or in part, of establishing such a plan.” 29 U.S.C. § 1002(4).

51 29 U.S.C. § 1002(1). 52 29 U.S.C. § 1002(7). 53 29 U.S.C. § 1002(5). 54 83 Fed. Reg. 614, supra note 24.55 29 U.S.C. § 1144. 56 See 29 U.S.C. § 1144(b)(6)(A).57 Fuller v. Norton, 86 F.3d 1016, 1024 (10th Cir.

1996); Atlantic Healthcare Benefits Trust v. Googins, 2 F.3d 1, 5 (2d Cir.1993), cert. den’d, 510 U.S. 1043 (1994).

58 129 Cong. Rec. 30356 (1982) (statement of Rep. Erlenborn).

59 129 Cong. Rec. 30355 (statement of Rep. Rostenkowski).

60 Fuller v. Norton, 86 F.3d 1016, 1025 (10th Cir. 1996).

61 See 29 U.S.C. § 1144(b)(6)(A). 62 tHoMson reuters, 50 stAte stAtutory

surveys, MultiPle eMPloyer WelFAre ArrAnGeMents (Dec. 2017).

63 Id.64 Id.65 29 U.S.C. § 1151(e); 29 C.F.R. § 2560.521-1(f).66 29 U.S.C. § 1151(a); 29 C.F.R. § 2560.521-1(c).67 29 U.S.C. §§ 1131(b), 1149.68 83 Fed. Reg. 614, supra note 24, at 625.69 Id. at 635 (to be codified at 29 C.F.R.

§ 2510.3-5(b)(8)).70 29 U.S.C. §§ 1001 et seq.71 See u.s. deP’t oF lAbo r, MultiPle

eMPloyer WelFAre ArrAnGeMents under tHe eMPloyee retireMent incoMe security Act: A Guide to FederAl And stAte reGulAtion at 15 (Feb. 2013).

72 29 U.S.C. § 1102(21)(A).73 29 U.S.C. § 1104.74 29 U.S.C. §§ 1109, 1105.75 29 U.S.C. § 1132(l).76 Hunt, supra note 46.77 See u.s. deP’t oF justice, Antitrust div.,

And FederAl trAde coMMission, stAteMents oF Antitrust enForceMent Policy in HeAltH cAre, at stAteMent 8, PHysiciAn netWork joint ventures (Aug. 1996).

78 See id. at stAteMent 9, enForceMent Policy on MultiProvider netWorks.

79 An example of a successful messenger mode is one employed by Bay Area Preferred Physicians (“BAPP”) and approved by the FTC in a 2003 advisory opinion. In the BAPP arrangement, BAPP had a non-physician employee act as a messenger. The messenger collected from each physician minimum acceptable payment terms for common medical procedures and determined which were at or below the payor’s offer. The messenger also notified physicians whose minimum payment demands exceeded the offer and allowed them to “opt in” to a contract containing the payor’s offer. The messenger then determined the percentage of physicians willing to accept the payor’s offer. If the percentage was 50% or greater, the messenger could contract with the payor on behalf of all willing participants. If the percentage was less than 50%, the messenger could contract with the payor only if the payor agreed to cover contract administration costs. The messenger was prohibited from sharing with physicians the number or percentage of physicians whose payment levels met or were below the payor’s offer. letter FroM jeFFrey W. brennAn to MArtin j. tHoMPson concerninG ProPosAl to creAte A PHysiciAn netWork in tHe sAn FrAncisco bAy AreA, Ftc oP. (Sept. 23, 2003).


The Editorial Board provides expertise in specialized areas covered by the Section. Individual Board members were appointed by the Interest Group Chairs and Editor Marla Durben Hirsch. If you are interested in submitting an article to The Health Lawyer, you may contact one of the Editorial Board members or Ms. Hirsch. With the establishment of the Editorial Board, the Section strengthens its commitment to provide the highest quality analysis of topics in a timely manner.

Marla Durben Hirsch Potomac, Maryland

301/299-6155 [email protected]

Bruce F. HowellSchwabe, Williamson & Wyatt, PC

Portland, OREditorial Board Chair


Howard D. Bye-TorreStoel Rives LLP

Seattle, WA Employee Benefits & Executive

Compensation 206/386-7631

[email protected]

Janet DolginHofstra University

Maurice A. Deane School of LawHempstead, NY

Public Health & Policy516/463-5873

[email protected]

Scott R. GrubmanChilivis, Cochran, Larkins & Bever, LLP

Atlanta, GAHealthcare Fraud & Compliance


Reesa HandelsmanWachler & Associates

Royal Oak, MIBusiness and Transactions


Rakel M. MeirBiogen Idec Inc.Cambridge, MA

Managed Care and Insurance617/914-5897

[email protected]

Conrad MeyerChehardy Sherman

Metairie, LAHealth Care Facility Operations


Michael MortonLegislative Counsel Bureau

Carson City, NVYoung Lawyers Division


Kirk J. NahraWiley Rein LLPWashington, DC

eHealth, Privacy & Security202/719-7335

[email protected]

Monica P. NavarroVezina Law

Birmingham, MIPhysician Issues248/558-2702

[email protected]

Jennifer L. RangelLocke LordAustin, TX

Liaison to the Publications Committee512/305-4745

[email protected]

Leonard M. RosenbergGarfunkel Wild, PC

Great Neck, NYHealthcare Litigation & Risk Management


W. Thomas SmithManchester University College of Pharmacy

Fort Wayne, INLife Sciences


Felicia Y. SzeRotenberg & Sze, LLP

San Francisco, CAPayment & Reimbursement


Norman G. Tabler, Jr.Faegre Baker Daniels LLP

Indianapolis, IN Tax & Accounting



THE PRICE IS RIGHT? WHAT IS “USUAL, CUSTOMARY AND REASONABLE” BETWEEN PROVIDER AND PAYORBy Nina Zhang, Esq. Stephenson, Acquisto & Colman Burbank, CA

In most markets, consumers can easily determine what they should be paying for a good or service. For example, to buy jeans, consumers can flip open a catalog or drive to the nearest mall. They can compare prices across brands and at different stores, and if they do not know why one pair costs $500 and another costs $50, they can talk to a sales clerk. They can further make a note of the brand of the jeans; then, when they arrive home, they can research the brand on the Internet to understand what they are paying for.

Healthcare is not like that. The market price is not visible, and con-sumers cannot readily access it or com-pare it across providers.1 People rely on their health insurer to negotiate prices with contracted providers, creating a network of participating providers. But often people receive care “out of net-work” from a noncontracted provider, such as when they need a specific pro-cedure, see a certain doctor and most frequently, when they must go to the nearest emergency room. When care is obtained out of network, patients are frequently unaware of the fact that the prices have not been determined ahead of time and that providers and payors rely on a murky rule, i.e. what is the usual, customary, and reasonable, or “UCR” rate, to determine the cost of care. In this age of consumer directed healthcare and increased patient cost sharing, the patients’ share of out of network costs may be significant. Thus, unless a state prohib-its balance or surprise billing,2 the dif-ference between what the provider charges and the insurer pays shifts to the consumer.

Because UCR is a standard that lacks clear guidance, payment disputes

often arise between providers and payors; providers typically want to be paid their total billed charges,3 while insurers want to pay substantially less. Federal law has historically been silent as to what the UCR rate is; only the federal health insurance exchange website provides some clari-fication, stating that “usual, custom-ary and reasonable” is the amount paid for a medical service in a geo-graphic area based on what providers in the area usually charge for the same or similar medical service.4 Pay-ors and providers, and sometimes elected officials, have challenged what this amount should be.

History of Usual, Customary and Reasonable

The “usual, customary and rea-sonable” payment method emerged in 1965 when the federal government enacted Medicare and Medicaid and the United States saw the slow and steady rise of health insurance.5 Previ-ously, patients paid physicians directly; physicians’ primary source of income was what the average patient paid.6 Concerned that physicians would become locked into a schedule of fixed fees, the American Medical Association (“AMA”) campaigned successfully for a new method of pay-ment that would allow its physician members to retain flexibility and avoid a fee ceiling.7 Consequently, Congress developed and enacted a system that mandates payments on the basis of the regular (usual) fee of any physician who the patient cares to choose (assuming it to be within the range of customary fees in that area, or if precedent is lacking, to be reasonable).8 Among private insurers, in the late 1960s Blue Shield imple-mented its own UCR program in response to the major labor and man-agement negotiators of that period

who wanted complete coverage for their members.9

Unsurprisingly, new doctors started billing insurers at unprece-dented levels, lacking a record of charges, so that their “usual” fee could be whatever they chose.10 Seeing that they could earn more money, more experienced doctors followed suit.11 Physicians and hospitals, no longer having to deal directly with patients, faced little pushback. Consequently, costs exploded.12

Recognizing that Medicare costs were spiraling out of control, Congress and the Reagan administration enacted an alternative payment system devel-oped by researchers at Yale University.13 Rather than allowing hospitals to charge whatever they wanted, the new model paid hospitals a predeter-mined, set rate based on the patient’s diagnosis and the average cost of resources used by all U.S. hospitals, the diagnosis related group (“DRG”) rate.14 This changed the incentives for hospitals; previously, the more a hos-pital did for its patients, the more money it received in payments, but now if a hospital could treat the patient for less than the DRG rate, it could keep the difference. Thus, hospitals had to be concerned about how long a patient stayed, the tests and procedures used during the stay, and how much was paid for the resources used in car-ing for the patients. This change helped lower Medicare hospital pay-ment increases by reducing Medicare patients’ days of care but did not neces-sarily reduce overall costs.15

The healthcare industry would later develop additional methods of controlling costs, such as capitation, accountable care organizations and forms of bundling. Yet UCR rates remain a vestige of America’s initial payment system and is alive and well in dealings between providers and



private payors, typically arising when the payor and provider lack a con-tract. They have also been the subject of considerable controversy.

Fairness and Accuracy of UCR Questioned

State Attorney General-Ingenix Lawsuit

In 2008, then New York State Attorney General Andrew Cuomo16 challenged what should be “usual, customary and reasonable.” He had the year before launched the Commu-nity Partnership Initiative, a series of community fora he held throughout New York State.17 In these fora, he and his team spoke to residents on key issues: e.g., employment, student loans, and law enforcement.18 He found that one of the chief concerns was the cost of healthcare.19 Often left with a hefty balance, consumers did not know whether doctors were overcharging or insurers underpay-ing20 and did not understand fully when they might be subject to these types of charges.

The Attorney General launched an investigation into insurers’ billing practices and found that the nation’s largest insurers used a database devel-oped by Ingenix, a wholly-owned sub-sidiary of UnitedHealth Group, Inc., to determine UCR rates. Ingenix col-lected billing data from a variety of health insurers,21 pooled the data and licensed schedules to insurers.22 Sub-sequently, the Attorney General announced an intent to sue Ingenix and some of UnitedHealth Group’s other subsidiaries.

As part of this investigation, Cuomo also subpoenaed documents, including bills, from 16 other insurers, including Aetna, Cigna and Well-Point. After reviewing millions of bills, Cuomo’s office developed its own database of what should be “usual, customary, and reasonable.” For example, the Attorney General found that statewide, for just doctors’

office visits, insurers relying on the Ingenix database systematically under-reimbursed New Yorkers 28 percent.23 Further, it found that Ingenix lacked quality control mechanisms over the data it received and the statistical methodologies it applied.24

Without admitting any wrongdo-ing, UnitedHealth Group ultimately settled with the Attorney General.25 It agreed to stop using Ingenix and to pay $50 million to finance the cre-ation of an independent, third-party database that consumers could use to compare prices.26 Other insurers agreed to stop using Ingenix and to finance the creation of the independent data-base.27 UnitedHealth Group also agreed to shut down Ingenix.28

The Rockefeller Investigations

Around the same time, U.S. Sen-ator Jay Rockefeller, chair of the Sen-ate Finance Committee, expanded Cuomo’s investigation to a wider net of insurers29 and convened hearings on the issue of out of network charges.30 The hearings prompted a deeper investigation by Congressional staff, which ultimately produced a report: “Underpayments to Consumers by the Health Insurance Industry.” They found that the use of Ingenix data was more prevalent than Congressional staff members initially believed: as the only source of medical claims data, Ingenix was used nationwide, not just in New York State.31 Further, the hear-ings and report documented Ingenix’s practice of removing high charges from its claims data, which made med-ical charges appear lower than they really were in the marketplace.32

The Aftermath of Ingenix

In October 2009, using $100 mil-lion the settlements collectively pro-vided, the New York State Attorney General launched Fair Health, Inc., an independent third-party database. Fair Health, Inc. includes Fair Health Consumer, an Internet portal that consumers can navigate to under-stand their health insurance policies. It contains a search feature where

consumers can find out the prevailing rate for a specific healthcare proce-dure in a geographic area.

However, the settlement agree-ments did not require insurers to use the new Fair Health database.33 Rather, it allowed them to use any clear, objective method of calculating reimbursement.34

Consequently, insurers started using multiples of Medicare rates as their definition of what was usual, cus-tomary and reasonable, even though the patients were not eligible for Medicare.35 However, this methodol-ogy has not resolved the issue of high costs. Medicare was never intended to be a fee schedule for the general popu-lation.36 Rather, it reflects policy deci-sions made by the federal government about how it pays certain specialties for the elderly and disabled.37 Further, Medicare rates are drastically lower than providers’ billed rates. When given a choice between paying Medi-care rates or Fair Health rates, employ-ers who sponsor healthcare plans have unsurprisingly chosen to pay Medicare rates.38 Thus, with employers and insurers paying out of network provid-ers less, when consumers receive sur-prise bills reflecting the difference between what insurers reimburse out of network providers and the provid-ers’ billed charges, they are still left with a hefty balance to pay.

Today, Fair Health has broad uses. It licenses its data and data products to commercial insurers and self-insurers, employers, hospitals and healthcare systems, government agen-cies, researchers and others.39 Fair Health has been certified by the Centers for Medicare & Medicaid Services (“CMS”) as a Qualified Entity,40 eligible to receive all Medi-care Parts A, B and D claims data for use in nationwide transparency efforts.41 Some states have designated Fair Health as the official, neutral source of cost information for a variety of state health programs, including workers’ compensation and personal


injury protection (“PIP”) programs.42 Other states have referenced Fair Health in their statutes and regulations.43

States Also Tackle What UCR Rates Are

Because federal law has not addressed the issue of what is usual, customary and reasonable, states have dealt with the issue independently, some by legislation and some via court decision. Across states, adjudi-cators revert to equitable quantum meruit principles, addressed on a case-by-case basis. Additionally, a universe of factors exists for an adju-dicator to consider, further muddying the issue.44

California

California has some of the stron-gest guidance on what is usual, cus-tomary and reasonable,45 thus meriting a deeper discussion. The state legisla-ture has codified several factors, com-monly known as the Department of Managed Health Care (“DMHC”) factors that weigh in the determina-tion: (1) the provider’s training, quali-fications, and length of time in practice; (2) the nature of the services provided; (3) the fees usually charged by the provider; (4) prevailing pro-vider rates charged in the general geo-graphic area in which the services were rendered; (5) other aspects of the economics of the medical provider’s practice that are relevant;46 and (6) any unusual circumstances in the situation.

On June 10, 2014 the California Court of Appeals for the Fifth Appel-late District broadened the criteria, holding in Children’s Hospital Central California v. Blue Cross of California 47 that the DMHC factors do not pro-vide the exclusive standard for valuing the services provided, but rather set the minimum criteria, and rejected the hospital’s contention that its

billed charges alone determined rea-sonable and customary value.48 The court also rejected Blue Cross’s con-tention that Medi-Cal rates estab-lished reasonable value. Instead, the court held that “relevant evidence would include the full range of fees that Hospital both charges and accepts as payment for similar ser-vices. The scope of the rates accepted by or paid to Hospital by other payors indicates the value of the services in the marketplace. From that evidence, along with evidence of any other fac-tors that are relevant to the situation, the trier of fact can determine the reasonable value of the particular ser-vices that were provided, i.e., the price that a willing buyer will pay and a willing seller will accept in an arm’s length transaction.”49

Goel v. Regal Medical Group, Inc.,50 decided three years later, takes the law in a different direction. In Goel, the parties disputed the price of prestabilization emergent services for non-government sponsored patients, i.e. non Medi-Cal and Medicare patients.51 The court found that 150 percent of Medicare rates, i.e. what Regal Medical Group, Inc. paid Dr. Goel for his services, was a usual, cus-tomary and reasonable rate based on the testimony of Regal’s expert that the rates Regal paid were above the national average for the procedures that Goel performed and that it is typical in the healthcare industry for payors to use the Medicare rate in determining the rates that they will pay.52 However, the court did not limit rates to a certain geography, as required by the DMHC factors. Fur-ther, the court did not discuss the other factors, such as the provider’s training, qualifications and length of time in practice.

Other States’ Interpretations of What’s UCR

California is not the only state that has dealt with the issue; other

states have developed similar defini-tions for what is usual, customary and reasonable. For example, in Tennes-see courts consider several factors including (1) the hospital’s full stan-dard rate; (2) the plan’s in-network reimbursement rate; (3) the industry’s customary rate; and (4) the plan’s disallowance of claims previously authorized, appeal and approval pro-cedures and delays in payment.53 In Illinois, courts consider (1) the hospi-tal’s costs and (2) charges of other hospitals in the area.54 In New Jersey, courts consider charges of other hos-pitals in the area.55

Feds Weigh In: UC Irvine Health v. Global Excel Management

The United States District Court, Central District of California recently decided a case addressing what is usual, customary and reason-able and thus takes one step closer to clarifying the issue post-Ingenix.56 In 2016, the Regents of the University of California on behalf of UC Irvine Medical Center sued Global Excel Management (“Global”), a Canadian claims administration company, for the quantum meruit value of the hos-pital services it rendered to British and Canadian travelers who entered UC Irvine Health’s emergency rooms for both pre-stabilization and post-stabilization emergency services. After UC Irvine Health treated the patients, Global paid 120 percent of Medicare rates for one patient and 200 percent of Medicare rates for another even though UC Irvine Health asked for total billed charges, since Global lacked a contract with UC Irvine Health.57

During the trial, Global argued that in pricing the claims, it looked at UC Irvine Health’s costs, contend-ing that its payment covered the hos-pital’s cost and provided for a slight

The Price is Right? What is “Usual, Customary and Reasonable”continued from page 13


profit.58 Representatives from UC Irvine Health countered that: (1) Global could not receive the benefit of paying discounted rates because it did not supply a volume of patients that justified a discounted fee and (2) Global never entered into an arms-length transaction with UC Irvine Health.

Both parties hired expert wit-nesses to testify what should be “usual, customary and reasonable.” The Court ultimately decided in a ruling January 2018 that Global would pay a higher percent of total billed charges than what Global ini-tially paid,59 an amount the Court deemed to be the market value for the medical services rendered. The Court based this conclusion on the fact that UC Irvine contracted with a preferred provider organization (“PPO”) net-work that effectively acted as a mid-dleman between non-contracted healthcare providers and payors, including Global. Under the agree-ment with this network, insurance companies and other payors received a certain percent discount on UC Irvine Health’s total billed charges.

The Court disagreed with Glob-al’s claim that the costs of the ser-vices provided are relevant to a determination of reasonable value, reasoning that quantum meruit mea-sures the value of services to the recipient, not the costs to the pro-vider. Further, the Court found the following factors relevant: (1) UC Irvine Health’s training, qualifica-tions and length of time in practice;60 (2) the nature of the services pro-vided;61 (3) the fees usually charged by UC Irvine Health;62 and (4) the fees usually charged in the general geographical area in which the ser-vices were rendered.63 Additionally, the Court found relevant UC Irvine Health’s 70 percent government payor mix.64 Further, the Court dis-tinguished Goel on the grounds that UC Irvine Health’s charges are not considered outliers.

The Court also addressed Glob-al’s argument that all hospitals bill unreasonable amounts based on the chargemaster method. As the Court stated, this issue is better left to the legislature because such charges to commercial payors are likely affected by Medicare and Medicaid. The Court further said that while claims that medical expenses and hospital charges may be unreasonably high in the United States, parties like Global should not avoid paying full billed charges or the applicable PPO dis-counted rate simply because they believe the charged rates are unrea-sonable across the board.

ConclusionUCR will remain an unsettled

area of law for the foreseeable future unless more judicial or legislative guidance is issued regarding what is UCR. Courts will likely develop the law further, since these decisions raise several questions not yet addressed. For example, (1) How will prices be deter-mined for non-emergent services, such as from an out of network specialist? (2) Can market price really be deter-mined by what a hospital accepts as payment for a service, when those pay-ments reflect a discount, the result of what a hospital and an insurer negoti-ated? (3) Can a hospital and insurer ever enter into an arm’s length transac-tion for emergent services, when hospi-tals must treat patients regardless of insurance?65 (4) How will prices be determined when the hospital is in network, but emergency medical doc-tors are not and insist on a different billed amount? (5) Can Medicare rates truly represent what parties achieve from an arm’s length transaction, when Medicare rates are nonnegotiable?

The stakes are growing, as costs are frequently passed onto patients in UCR situations. For patients, perhaps with the increase in use of out of network services either by choice or by chance, patients will finally push back against escalating and unregulated charges.

Nina Zhang is a healthcare litigation attorney at the Law Offices of Stephenson, Acquisto & Colman in Burbank, California. She

currently represents hospitals in payment disputes against insurers. She can be reached at [email protected].

Endnotes1 As used in this article, “providers” refers to

both institutional and individual providers, including hospitals and physicians.

2 The states that prohibit balance billing are California, Connecticut, Florida, Illinois, Maryland and New York. See Lucia, et al., Balance Billing Health Care Providers: Assessing Consumer Protects Across States, Issue Brief, Commonwealth Fund (2017).

3 For instance, hospitals maintain a uniform schedule of the charges they bill for all proce-dures, services and goods provided to patients, known as a “chargemaster.” Hospitals update their chargemasters yearly. In determining the percentage price increase, hospitals consider many factors, including their overall cost structure, financial position and contracts with payors. When insurers or other payors contract with hospitals who are not accepting risk in a capitation contract, they receive a discounted rate, such as a reduced percentage of the chargemaster in exchange for a certain volume of patients as well as prompt payment.

4 Healthcare.gov, https://www.healthcare.gov/glossary/ucr-usual-customary-and-reasonable/ (last visited December 13, 2017).

5 For a comprehensive discussion of the rise of health insurance, see Paul Starr, The Social Transformation of American Medicine (Basic Book Publishers, Inc. 1982).

6 Benson B. Roe, M.D., The UCR Boondoggle, 35 neW enG. j. Med. 41, 41 (1981).

7 Id. 8 Id. 9 Saul S. Radovsky, M.D., Letter to the Editor,

neW enG. j. Med., November 19, 1981.10 Benson B. Roe, M.D., The UCR Boondoggle,

35 neW enG. j. Med. 41, 41 (1981).11 Id. 12 Id. 13 Rick Mayes, The Origins, Development, and

Passage of Medicare’s Revolutionary Prospective Payment System, 62 j Hist. Med Allied sci. 21, 21 (2007).

14 Id. 15 Stuart H. Altman, The Lessons of Medicare’s

Prospective Payment System Show That the Bun-dled Payment Program Faces Challenges, 31 HeAltH AFFAirs 1923, 1928 (2012).

16 Andrew Cuomo is now the governor of New York State.



The Price is Right? What is “Usual, Customary and Reasonable”continued from page 15

17 Attorney General Launched State Wide Community Partnership Initiative with Bing-hamton as First Site, https://ag.ny.gov/press-release/attorney-general-cuomo-launched- statewide-community-partnership-initiative-binghamton (last visited December 13, 2017).

18 Id.

19 Linda A. Lacewell et al., The Health Care Report, The Consumer Reimbursement System is Code Blue, at 1 (2009).

20 Id. at 17.21 Ingenix had purchased the Prevailing Health-

care System Charge from the Health Insur-ance Association of America in 1973 and the Medical Data Resource from Medicode, Inc. in 1997. With those two purchases, Ingenix con-trolled the only two national UCR databases.

22 Lacewell, at 2.23 Id. 24 Id. at 22.25 The Attorney General did not charge or sue

any of the insurers. However, around the same time, various insurers faced lawsuits from the American Medical Association and subscrib-ers. See American Medical Ass’n v. United Healthcare Corp., 2009 WL 4403185 (S.D. N.Y. 2009) ($350 million settlement granted); Wach-tel v. HealthNet, 569 F. Supp. 2d 448 (D.N.J. 2008) ($215 million settlement granted); In re: Aetna UCR Litigation, Case No: 07-CV-3541, MDL 2020 (D.N.J) ($120 million granted).

26 Attorney General Announces Historic Nationwide Reform of Consumer Reimburse-ment System for Out-of-Network Health Care Charges, https://ag.ny.gov/press-release/attorney- general-cuomo-announces-historic-nationwide- reform-consumer-reimbursement (last visited December 13, 2017).

27 Id.

28 Assurance of Discontinuance Under Execu-tive Law § 63(15), In re UnitedHealth Group Incorporated, Investigation No. 2008-161, Office of New York Attorney General (“Assurance of Discontinuance”).

29 The insurers include AIG; American Family Corp. Group; BlueCross BlueShield of Califor-nia; BlueCross BlueShield of Florida; BlueCross BlueShield of Massachusetts; BlueCross BlueShield of Michigan; BlueCross BlueShield of New Jersey; CareFirst, Inc.; Coventry Health Care Inc.; HCSC Group; Highmark Inc.; Humana Group; Independence Blue Cross; Health Net of California; Kaiser Foundation Group; Regence Corp.; and UnumProvident.

30 The hearings took place on March 26 and March 31, 2009.

31 Office of Oversight and Investigations, Senate Committee on Commerce, Science and Trans-portation, Underpayments to Consumers by the Health Insurance Industry (June 24, 2009), at 3.

32 Id. at 6. Congressional staff members dis-cussed sources, such as expert reports submit-ted in earlier lawsuits against health insurers.

33 Nina Bernstein, Insurers Alter Cost, and Patients Pay More, N.Y. Times, April 23, 2012, http://nytimes.com/2012/04/24/nyregion/

health-insurers-switch-baseline-for-out-of-network-charges.html.

34 Id.

35 Id.

36 John Carroll, Reformed UCR Calculations Not Without Problems, Managed Care, June 30, 2012, https://www.managedcaremag.com/archives/2012/6/reformed-ucr-calculations- not-without-problems.

37 Id.

38 Id. 39 Fair Health, Nation’s Largest Private Healthcare

Database Acquires All Medicare Claims Data, March 15, 2017, PR Newswire, https://www.prnewswire.com/news-releases/nations-largest-private-healthcare-database-acquires-all-medicare-claims-data-300423650.html.

40 The CMS Qualified Entity (“QE”) Program enables organizations to receive Medicare claims data under Parts A, B, and D for use in evaluat-ing provider performance. Organizations approved as QEs are required to use the Medi-care data to produce and publicly disseminate CMS-approved reports on provider performance.

41 Id.

42 Id. 43 For example, Connecticut has designated Fair

Health’s 80th percentile charge benchmarks for healthcare services as the usual, customary and reasonable rate to be used for out of network, surprise emergency care bills. See Fair Health, Connecticut Consumer Protection Law Desig-nates FAIR Health Data Out-of-Network Reim-bursement Reference Point, July 6, 2016, PR Newswire, https://prnewswire.com/news-releases/connecticut-consumer-protection-law- designates-fair-health-data-out-of-network- reimbursement-reference-point-300294308.html.

44 Since some states prohibit balance billing, payors and providers have additional monies they need to adjudicate that insurers other-wise would pass onto patients.

45 California Code of Regulations, title 28, sec-tion 1300.71, subdivision (a)(3)(B) defines “Reimbursement of a Claim” for noncon-tracted providers as the payment of “the rea-sonable and customary value for the health care services rendered.”

46 “Provider” refers to both hospitals and other entities that provide medical services.

47 In Children’s Hospital Central California, the parties disputed the price of medical services for post-stabilization care. Under state and federal law, a hospital with an emergency department must treat patients who enter for emergent conditions until the patients stabi-lize, regardless of the patient’s insurance or ability to pay. Emergency Medical Treatment and Labor Act (“EMTALA”), 42 U.S.C. § 1395dd(a), (b), Cal. Health & Safety Code § 1317. When the hospital has determined that the emergency medical condition has sta-bilized, an insurer may require prior authoriza-tion as a condition for payment for necessary post-stabilization medical care. Cal. Health & Safety Code § 1371.4, subdivision (c).

48 Children’s Hospital Central California v. Blue

Cross of California, 226 Cal.App.4th 1260 (2014).

49 Id. At 1275.50 Goel v. Regal Medical Group, Inc., 11 Cal.

App.5th 1054 (2017).51 From the decision, it is unclear if Regal was a

capitated provider in this instance. 52 Id. at 1059, 1064.53 River Park Hospital, Inc. v. BlueCross Blue

Shield of Tennessee, No. M2001-00288-COA-R3-CV, 2002 WL31302926 (Tenn. Ct. App. Oct. 11, 2002).

54 Victory Memorial Hospital v. Wright, 143 Ill. App. 3d 621 (1986).

55 Hahnemann v. University Hospital, 678 A.2d 266 (N.J. Super Ct. App. Div. 1996).

56 Regents of the University of California, a public trust corporation, on behalf of the University of California, Irvine Medical Center v. Global Excel Management, Inc., No. 8:16-cv-00714-DOC-E (C.D. Cal., filed Jan. 21, 2016). The Court entered a judgment on January 29, 2018.

57 The patients were not eligible for Medicare. 58 Global consulted UC Irvine Health’s cost-to-

charge ratio, the amount Medicare would have paid, the amount UC Irvine Health typ-ically receives from all payors and the amount UC Irvine Health typically receives from commercial payors. The primary factor was the hospital’s costs, based on the Medicare DRG. Plaintiff ’s expert witness performed a global assessment of UC Irvine Health’s paid claims data and determined that the amounts Global paid were almost 20 percentage points below what most contracted payors paid. However, the data included all payors, and included bad debt, charity care and zero reim-bursement accounts.

59 The exact percentage the Court decided that Global should pay remains under seal.

60 The Court found that UC Irvine Health’s costs are justifiably higher than its peer hospi-tals due to the higher level of care it renders as a Level I trauma center and Level II pediat-ric trauma center.

61 The Court noted that UC Irvine Health pro-vided emergent and inpatient ICU services.

62 The Court found that UC Irvine Health received a higher percentage of total billed charges for emergent and inpatient ICU services.

63 The Court found UC Irvine Health’s 2014 charges to be within the 75th and 90th per-centile of all other hospitals in Orange County, California.

64 Seventy percent of UC Irvine Health’s payors is Medicare, Medicare managed health, Medi-Cal and Medi-Cal managed health. As the Court found, to continue to offer advanced services and high-quality care, UC Irvine Health depends on both contracted and non-contracted payors for revenue.

65 Under EMTALA, hospitals must treat patients who enter for emergent care regard-less if they are covered and no matter their ability to pay. See supra note 47.


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representatives; I vote in the general elections, but rarely in the primaries. It is tempting to think one voice or one vote cannot change anything. But despair is enervating and is not the answer. Being an informed, vocal and active citizen is. We are not all going to agree with or like the solutions our representatives put in place, but they need to know what we think as they go about their work of developing legislation. And we let them know what we think by giving them our thoughts and ideas, and by voting at every opportunity.

As lawyers and members of the ABA, this reminder resonates. The ABA has had a long-time commitment to the rule of law. The mission of the ABA is grounded in four goals, and Goal IV is to advance the rule of law with the following objectives:

1. Increase public understanding of and respect for the rule of law, the legal process, and the role of the legal profession at home and throughout the world.

2. Hold governments accountable under law.

3. Work for just laws, including human rights, and a fair legal process.

4. Assure meaningful access to justice for all persons.

5. Preserve the independence of the legal profession and the judiciary.

If it feels like our governmental institutions are under attack at worst or immobilized at best, it is incumbent upon us as lawyers to do our part. We are uniquely equipped to pur-sue the objectives of Goal IV because we are educated and understand the legal process. We can follow the students’ lead to promote respect for the rule of law while holding our government accountable under existing laws, working for just laws and a fair legal process, and maintaining the indepen-dence of the legal profession and the judiciary.

As we move into the primaries for the mid-term elections, may we all meet our obligations as responsible lawyers and citi-zens to make our voices heard. Let us communicate with our representatives and cast our ballots in the voting booth. Let us do what we can to combat the senseless violence we have seen most recently in Parkland, Florida. And let us continue to protect and strengthen our country through the rule of law.

Hilary H. Young

Chair’s Corner continued from page 2

Section news


Sean McGrath Wins the 2017 ABA Health Law Section Law Student Writing Competition

The Section congratulates Sean McGrath of St. John’s University School of Law in Queens, New York, who was selected as the winner of the Section’s 2017 Law Student Writing Competition. Sean’s submission, “Courts Struggle to Balance Bedrock Principles of Antitrust Law with Policy Implications of Nonprofit Hospital Mergers,” is slated to be published in a future edition of The Health Lawyer. He was a guest at the 19th Annual Conference on Emerging Issues in Healthcare Law in Scottsdale, Arizona this past February.

Samantha Smyth of Case Western Reserve University School of Law School in Cleveland, Ohio was selected runner up in the competition.

Her paper, “Law Enforcement’s Uses of Narcan in Criminal Investigations and the Consequences of Police Involvement in the Opioid Epidemic” is also slated to be published in The Health Lawyer.

Kelly H. Oshiro of the University of Oregon School of Law in Eugene, Oregon and Kayla K. Mahoney of Willamette University College of Law in Salem, Oregon won honorable mentions in the competi-tion. Their papers were entitled respectively “The Scope of Trade Secret Protection in Accountable Care Organizations Without Incurring an Antitrust Violation” and “Pulling the Plug on Washington v. Glucksberg.”

W. Thomas Smith Receives the Champion of Diversity and Inclusion Award

The Health Law Section is pleased to announce W. Thomas Smith as the recipient of this year’s Champion of Diversity and Inclusion Award. The award honors an ABA Health Law Section member who has made exceptional efforts to promote diver-sity and inclusion within the Section and /or the legal profession. Mr. Smith is a Dean of Pharmacy at the Manchester University College of Pharmacy in Fort Wayne, Indiana. The award was presented to him on February 21, 2018 at the Section’s Emerging Issues Conference in Scottsdale by Diversity Committee Chair Tiffany Santos. Adrienne Dresevic and Clinton Mikel of the Health Law Partners in Farmington Hills, Michigan nominated Mr. Smith for the award.

Adrienne Dresevic and Clinton Mikel congratulate W. Thomas Smith (center) at the 19th Annual Emerging Issues in Healthcare Conference in Scottsdale.


Section news

COUNCIL MEMBERS-AT-LARGE(3-year terms ending 2021)

Nomination Slate for Officers and Council Members for FY 2019

The Nominating Committee is pleased to announce the slate of candidates for Officers and Council members for FY 2019:

Per Article VI, Section 1 of the Health Law Section Bylaws, notice is hereby given to the members of the Health Law Section. The election of such Officers and Council will occur at the Section Business Meeting during the ABA Annual Meeting in Chicago in August.

Automatic Ascension:

CHAIR (1-year term beginning August 2018)

Alexandria McCombs Humana, Irving, TX

CHAIR-ELECT (1-year term beginning August 2018)

John H. McEniry, IV Consors Consulting, Fairhope, AL

BUDGET OFFICER (3-year term beginning August 2018)

Adrienne Dresevic The Health Law Partners PC, Farmington Hills, MI

IMMEDIATE PAST CHAIR (1-year term beginning August 2018)

Hilary H. Young Joy & Young, LLP, Austin, TX

VICE-CHAIR(1-year term with automatic

ascension to Chair-Elect and Chair)

SECRETARY(1-year term)

SECTION DELEGATE TO ABA HOUSE OF DELEGATES

(3-year term)

Hal Katz Husch Blackwell LLP

Austin, TX

Kathleen L. DeBruhl Kathleen L. DeBruhl & Associates, L.L.C.

New Orleans, LA

Clay Countryman Breazeale Sachse & Wilson LLP

Baton Rouge, LA

Matthew R. FisherMirick, O’Connell, DeMallie & Lougee, LLP

Worcester, MA

Robyn Shapiro Health Sciences Law Group LLC

Fox Point, WI

Julian Rivera Husch Blackwell LLP

Austin, TX


Christine L. Noller, JD, LLM Assistant Professor, Health Science Saginaw Valley State University University Center, MI

The Tax Cuts and Jobs Act of 2017 (“TCJA”), P.L. 115-97 has sig-nificant implications for tax-exempt hospitals beyond the individual health insurance mandate repeal.1 In particular, it eliminates aggregation of income and deductions for unrelated business income tax (“UBIT”) com-putation2 and advance refunding of outstanding tax-exempt bonds. It also further imposes an excise tax for highly compensated non-profit employees. These changes require fur-ther consideration by hospitals as they diversify operations, access working capital, recruit executives and expand the role of physicians in non-medical and administrative positions.

Changes to the Corporate Tax Rate

Prior to enactment of the TCJA, corporate taxable income was subject to tax under a four-step graduated rate structure.3 Tax rates ranged from 15 percent on the first $25,000 of taxable income to 34 percent for taxable income over $75,000 with a maxi-mum rate of 35 percent for taxable income over $10 million. The TCJA eliminated the graduated corporate rate structure and instead taxes corpo-rate taxable income at 21 percent effective January 1, 2018.4

Calculation of UBIT of Tax-Exempt Hospitals with Multiple Unrelated Business Income Sources

Section 511 of the Internal Reve-nue Code (“IRC”) imposes a tax on the unrelated business taxable income5 of organizations described in IRC

Section 510(c)(3). IRC Section 513 defines unrelated trade or business as a trade or business the conduct of which is not substantially related to the exer-cise or performance by such organiza-tion of its exempt purpose.6 Unrelated business taxable income7 is taxable at the corporate income tax rate as dis-cussed above.

A trade or business is related to exempt purposes only where the con-duct of the business activity has a causal relationship to the achievement of an exempt purpose, and is substan-tially related for purposes of Section 513 only if the causal relationship is a substantial one. For conduct of a trade or business from which a particular amount of the gross income is derived to be substantially related for the pur-poses of which the Section 501(c)(3) exemption is granted, the production or distribution of the goods or perfor-mance of the services from which the gross income is derived must “contrib-ute importantly” to the accomplish-ment of those purposes.8 If the activity is not substantially related to the hos-pital’s tax-exempt purpose, UBIT would be incurred.

Prior to the TCJA, an organiza-tion operating multiple unrelated trades or businesses could aggregate income from all such activities and subtract from the aggregate gross income the aggregate of deductions to determine unrelated business taxable income.9 As a result, an organization could use a deduction from one unre-lated trade or business to offset income from another, thereby reducing total unrelated business taxable income. The TCJA eliminates the aggregate computation of unrelated business taxable income previously allowed under Treas. Reg. 1.152(a)-1(a).10

Instead, for an organization with more than one unrelated trade or business, unrelated business taxable

income must first be computed sepa-rately with respect to each trade or business (and without regard to the specific deduction generally allowed under Section 512(b)(12)).11 The organization’s unrelated business tax-able income for a taxable year is the sum of the amounts (not less than zero) computed for each separate unrelated trade or business (less the specific deduction allowed under Sec-tion 512(b)(12)). A net operating loss deduction is allowed only with respect to a trade or business from which the loss arose. The result of the provision is that a deduction from one trade or business for a taxable year may not be used to offset income from a different unrelated trade or business for the same taxable year. The provision gen-erally does not, however, prevent an organization from using a deduction from one taxable year to offset income from the same unrelated trade or busi-ness activity in another taxable year, where appropriate.12

The provision is effective for tax-able years beginning after December 31, 2017. However, under a special transition rule, net operating losses arising in a taxable year beginning before January 1, 2018 that are car-ried forward to a taxable year begin-ning on or after such date are not subject to the rule of the provision.13

Thus, tax-exempt hospitals with multiple unrelated taxable income sources should consider the UBIT implications of their operations, including joint ventures. The Internal Revenue Service (“IRS”) previously identified examples of UBIT to include non-patient laboratory testing performed by a tax-exempt non-teaching hospital on referred speci-mens from private office patients of staff physicians as an unrelated trade or business if these services are other-wise available in the community.14 An exempt hospital working closely

IMPACT OF THE TAX CUTS AND JOBS ACT OF 2017 ON TAX-EXEMPT HOSPITALS



with a for-profit clinic comprised of physicians on the hospital’s staff whose hospital pharmacy sells prescribed drugs to the clinic and its patients con-stitutes an unrelated trade or busi-ness.15 Even fitness clubs owned by tax-exempt healthcare organizations can, in certain circumstances, gener-ate unrelated business income.16

More recently, the IRS concluded that tax-exempt hospital participa-tion in accountable care organizations (“ACOs”) can also result in UBIT. While a tax-exempt participant’s share of an ACO’s Shared Savings payments17 generally are not subject to the UBIT as they derive from activities substantially related to the performance of the charitable purpose of lessening the burdens of govern-ment, UBIT may be imposed upon ACO non-Shared Savings Program activities if those activities are not related to charitable activities.18

Furthermore, as hospitals pursue joint venture opportunities via lim-ited liability companies (“LLCs”) and partnerships with for-profit physician groups and other entities, said joint ventures must demonstrate their activities to be substantially related to hospital members’ charitable purposes pursuant to Treas. Reg. 1.513-1(d)(2) to avoid the imposition of UBIT,19 especially as aggregate computations of (LLC member distributive share) income and deductions over multiple operations are no longer allowable.

Elimination of Advance Refunding of Outstanding Tax-Exempt Bonds

The TCJA will also change how hospitals engage in tax-exempt financing. IRC Section 103(a) pro-vides that, except as provided by Sec-tion 103(b), gross income does not include interest on any state or local bond. Section 103(b) provides that Section 103(a) shall not apply to any private activity bond20 that is not a qualified bond within the meaning of

Section 141. Under Section 141(e)(1)(G) qualified 501(c)(3) bonds are qualified bonds, the proceeds of which are tax-exempt.21

Qualified Section 501(c)(3) bonds are tax-exempt activity bonds issued by state and local governments, the proceeds of which are loaned to and used by a Section 501(c)(3) orga-nization in furtherance of its exempt (charitable) purpose. Tax exempt qualified Section 501(c)(3) bonds are commonly issued to finance long-term capital requirements of hospi-tals. Tax-exempt bond financing provides an important government subsidy allowing tax-exempt hospitals to realize lower borrowing costs asso-ciated with their debt financing.

The exclusion from income for interest on state and local bonds also applies to refunding bonds, but his-torically there have been limits on advance refunding bonds. A refunding bond is defined as any bond used to pay principal, interest, or redemption price on a prior bond issue (the refunded bond).22 Different rules apply to current as opposed to advance refunding bonds. A current refunding occurs when the refunded bond is redeemed within 90 days of issuance of the refunding bonds. Con-versely, a bond is classified as an advance refunding bond if it is issued more than 90 days before the redemp-tion of the refunded bond.23

Proceeds of advance refunding bonds have generally been invested in an escrow account and held until a future date when the refunded bond may be redeemed. Governmental bonds and qualified 501(c)(3) bonds could be advance refunded one time.24 Private activity bonds, other than qualified 501(c)(3) bonds, could not be advance refunded at all.25

This distinction ceases with the enactment of the TCJA. The TCJA repeals entirely the exclusion from gross income for interest on a bond issued to advance refund another bond issued after December 31, 2017, thus ending

all advance refunding.26 Elimination of advance refunding will negatively impact many hospitals to the extent that advance-refunding comprised about 25 percent of the municipal tax-exempt bond market in 2017.27 Further, the repeal could be of greater conse-quence to state and local governments, which use tax-exempt bonds to fund projects mitigating the social deter-minants of health,28 such as building housing for homeless populations.29

Excise Taxes for Highly Compensated Employees at Non-Profits

Historically, the reasonableness of compensation paid by a non-profit has been judged under the same stan-dard applied to business corporations, i.e. not to exceed what is reasonable under all of the circumstances.30 Rea-sonable and true compensation is only such amount as would ordinarily be paid for like services by like enter-prises under like circumstances.31

While the IRC does provide against private inurement extending to excess economic benefits received by insiders32 and intermediate sanc-tions for excess benefit transactions between exempt organizations and disqualified persons,33 neither estab-lished an excise tax for non-profit employee compensation.

The TCJA34 adds Section 4960 to the IRC which holds Section 501(c)(3) organizations to requirements of publi-cally held corporations relative to cov-ered employee compensation under IRC Section 142(m)35 and parachute payments under IRC Section 280(G).36

Section 4960 provides that tax-exempt employers are liable for an excise tax equal to 21 percent of the sum of (1) any remuneration, meaning wages as defined for income tax with-holding purposes,37 in excess of $1 mil-lion paid to a covered employee38 by an applicable tax-exempt organization for a taxable year, and (2) any excess


Impact of the Tax Cuts and Jobs Act of 2017 on Tax-Exempt Hospitalscontinued from page 21

parachute payment (under a new defi-nition for this purpose that relates solely to separation pay)39 paid by the applicable tax-exempt organization to a covered employee. Accordingly, the excise tax applies as a result of an excess parachute payment, even if the covered employee’s remuneration does not exceed $1 million.

Remuneration is treated as paid when there is no substantial risk of forfeiture of rights to such remunera-tion. For the purpose of this section, substantial risk of forfeiture is based on the definition under IRC Section 457(f)(3)(B) in that the person’s rights to compensation are conditioned upon his or her future performance of sub-stantial services.40

However, compensation attribut-able to medical services of certain qual-ified medical professionals are exempt from the definitions of remuneration and compensation. For purposes of determining a covered employee, remu-neration paid to a licensed medical pro-fessional, including a doctor or nurse, which is directly related to the perfor-mance of medical services is not taken into account. Remuneration paid to such a professional in any other capac-ity is taken into account.41

Thus, while remuneration rela-tive to medical practice would not apply to the $1 million excise tax, remuneration for administrative and other non-medical services arguably would. Physicians who serve multiple roles, including administrative, research, and/or teaching activities could be affected, as would their hos-pital employers for purposes of IRC Section 4960’s excise tax.

ConclusionThe TCJA’s changes to UBIT cal-

culations, advance bond refunding and excise taxes for highly compensated non-profit employees are significant and will cause hospitals to operate

differently. Tax-exempt hospitals should carefully assess their UBIT exposure for all operations, including joint ventures. As income and deduc-tions over multiple sources can no longer be aggregated, care must be taken to ensure that all ancillary oper-ations and activities contribute impor-tantly to and are substantially related to the hospital’s charitable purpose. Repeal of advance refunding bonds limits flexibility of bond issuers to take advantage of lower interest rates, resulting in higher borrowing costs by eliminating the ability of hospitals to take a one-time advance refunding of bonds. However, hospitals can con-tinue to use current refunding when bonds become currently callable.

The excise tax on highly compen-sated employees presents the greatest challenge, especially as applied to physicians who serve both medical and administrative roles. While the IRS has provided no guidance to date on allocation criteria (beyond the $1 million remuneration) or computation methods therewith, hospital adminis-trators and counsel should remain alert for any upcoming Proposed Trea-sury Regulations, relative to IRC Sec-tion 4960, published via Treasury Decisions in the Federal Register.

Christine Noller, J.D., L.L.M earned her Bachelor of Science in Clinical Dietetics from Michigan State University and her

Juris Doctorate (J.D.) and Master of Laws in Taxation (L.L.M.) from the Thomas M. Cooley Law School, specializing in taxation of non-profit organizations and healthcare regulation. Her academic areas of interest include Community Benefit, Community Health Needs Assessments, Community Health Improvement Programs and Population Health, patient safety, quality and Lean Process

Improvement. Her healthcare leadership and administrative experience includes operations and service line management in anesthesia services, wound services, surgical specialists, orthopedics, spine and rehabilitation and occupational health. Ms. Noller practiced law in the area of Workers’ Compensation. She is a member of the State Bar of Michigan’s Health Care Section and the American College of Healthcare Executives. She may be reached at [email protected].

Endnotes1 The TCJA is the tax reform bill introduced in

the 115th Congress (2017-2018) on Novem-ber 2, 1027, passed by the House of Represen-tatives on November 16, and the Senate on December 2, reported by the joint conference committee on December 15, agreed to by the Senate on December 20 and by the House of Representatives on December 19 and 20, then signed into law by President Donald Trump on December 22, 1017. Section 11081 eliminated the shared responsibility payment for individu-als failing to maintain minimum essential cov-erage, i.e. the individual mandate. Since 2014, the Patient Protection and Affordable Care Act (P.L. 111-148, as amended) has required most individuals to maintain health insurance coverage or potentially to pay a penalty for noncompliance. See U.S.C. § 5000A, https://www.congress.gov/bill/115th-congress/house-bill/1/text. On June 28, 2012, the U.S. Supreme Court issued its decision in National Federation of Independent Business v Sebelius, finding that the individual mandate in Sec-tion 5000A of the Internal Revenue Code (“IRC”) was a constitutional exercise of Con-gress’s authority to levy taxes. See National Federation of Independent Business v Sebelius, Secretary of Health and Human Services, 648 F. 3d 1235, https://www.law.cornell.edu/suprem-ecourt/text/11-393. According to the Con-gressional Budget Office (“CBO”), repealing the individual mandate starting in 2019 – and making no other changes to current law – would result in the number of people with health insurance to decrease by four million in 2019 and 12 million in 2027. Average pre-miums in the nongroup market would increase by about 10 percent in most years of the decade. See CBO Report, Repealing the Individual Health Insurance Mandate: An Updated estimate, November 8, 2017, at https://www.cbo.gov/publication/53300. Uninsured individuals receive large quantities of uncompensated care. Estimates based on the Medical Expenditure Panel indicate that a non-elderly individual uninsured for the entire year received $1,700 in uncompensated care, on average, during 2013. Increases in the number of uninsured individuals increase the amount of uncompensated care. Research focused on the hospital sector, which accounts for 3/5 of all uncompensated care, suggests that providers, i.e. hospitals, thereby



experience lower operating margins as a result. Furthermore, reductions in operating margins in response to increases in uncompensated care occur almost exclusively among non-profit hospitals. See Fiedler, Matthew, Repeal-ing the Individual Mandate Would Do Substantial Harm, The Brookings Institute Up Front, November 21, 2017, https://www.brookings.edu/blog/up-front/2017/11/21/repealing-the-individual-mandate-would-do-substantial-harm/, citing Craig Garthwaite, Tal Gross, and Matthew Notowidigdo, Hospi-tals as Insurers of Last Resort, Northwestern Faculty Research, January 2017, http://faculty.wcas.northwestern.edu/noto/research/GGN_hospitals_as_insurers_jan2017.pdf.

2 TCJA, Section 13702(a)(6).3 IRC Section 11(a) and (b)(1). 4 Section 13301(a) of the TCJA provides that

Subsection (b) of IRC Section 11 is amended to read as follows: the amount of tax imposed by subsection (2) shall be 21 percent of tax-able income.

5 IRC Section 512(a)(1) defines unrelated busi-ness taxable income as the gross income derived from any unrelated trade or business regularly carried on, less the allowable deduc-tions that are directly connected with the car-rying on of the trade or business both computed with certain modifications provided in Subsection (b), e.g. excluding dividends, interest, payments with respect to securities loans, amounts received or accrued as consid-eration for entering into agreements to make loans and annuities, all deductions directly connected with such income, royalties, rents from real and personal property, gains or losses from the sale, exchange or other disposition of property other than stock in trade or other property of a kind which would properly be includible in inventory if on hand at the close of the taxable year or property held primarily for sale to customers in the ordinary course of business. IRC Section 512(c)(1) provides that if a trade or business regularly carried on by a partnership of which an organization is a member is an unrelated trade or business, this organization in computing its unrelated trade or business income must include its share of the partnership’s gross income and deductions directly connected with such gross income. Section 512(c)(1) applies as well to limited liability companies (“LLCs”) treated as part-nerships for federal income tax purposes. See https://www.law.cornell.edu/uscode/text/26/512.

6 Treas. Reg. 1.513-1(b) states that the phrase “trade or business” includes activities carried on for the production of income which pos-sess the characteristics of a trade or business within the meaning of Section 162. Treas. Reg. 1.513-1(c) explains that “regularly car-ried on” refers to the frequency and continu-ity of the conduct of an activity and the manner in which the activity is pursued. Thus, activities of tax-exempt hospital joint ventures would constitute a “trade or busi-ness” that is “regularly carried on” for this pur-pose. See https://www.law.cornell.edu/cfr/text/26/1.513-1.

7 Treas. Reg. 1.153-1(a) defines unrelated busi-ness taxable income to mean gross income derived by the organization from any unre-lated trade or business regularly carried on by it, less directly connected deductions and

certain modifications. Gross income of an exempt organization subject to tax imposed by Section 511 is includible in the computation of unrelated business taxable income if it is income from trade or business, if such trade or business is regularly carried on by the opera-tion and the conduct of such trade or business is not substantially related to the organiza-tion’s performance of its exempt functions. See https://www.law.cornell.edu/cfr/text/ 26/1.513-1.

8 Treas. Reg. 1.513-1(d)(2), https://www.law.cornell.edu/cfr/text/26/1.513-1.

9 In the case of an organization which derives gross income from the regular conduct of two or more unrelated business activities, unrelated business taxable income is the aggregate of gross income from all such unrelated business activities less the aggregate of the deductions allowed with respect to all such unrelated busi-ness activities. Treas. Reg. 1.512(a)-1(a), https://www.law.cornell.edu/cfr/text/26/ 1.512%28a%29-1.

10 Section 13702 of the TCJA (Section 13703 of the Senate amendments) amends Subsec-tion (a) of IRC Section 512 by adding at the end the following new paragraph: (6) in the case of any organization with more than 1 unrelated trade or business – (A) unrelated business taxable income shall be computed separately with respect to each such trade or business and without regard to subsection (b)(12) and (B) the unrelated business taxable income or such organization shall be the sum of the unrelated business taxable income so computed with respect to each such trade or business, less a specific deduction under sub-section (b)(12) and (C) for purposes of sub-paragraph (B), UBIT with respect to any such trade or business shall not be less than zero.

11 IRC Section 512(b)(12) pertains to a deduc-tion applicable to a diocese, province of a reli-gious order, or a convention or association of churches, https://www.law.cornell.edu/uscode/text/26/512.

12 Tax Cuts and Jobs Act of 2017, Joint Explan-atory Statement of the Committee Confer-ence, page 410, http://docs.house.gov/billsthisweek/20171218/CRPT-115HRPT- 466.pdf.

13 Id. at 411.14 IRS Publication 598 (01/2017), Tax on Unre-

lated Business Income on Tax Exempt Orga-nizations, https://www.irs.gov/publications/p598. The IRS previously applied the “unique circumstances test,” of Rev. Rul. 85-110 in TE/GE Technical Advice Memorandum, 201428080 to conclude that a tax-exempt hospital’s performance of laboratory tests for patients of private physicians located in a medically underserved area and the surround-ing communities served by the hospital is not an unrelated trade or business within the meaning of Section 513. The provision of lab-oratory services for such persons is substan-tially related to and contributes importantly to the hospital’s tax-exempt purpose of improving the health of the medically under-served area and its surrounding communities, consistent with Treas. Reg. 1.513-1(d)(2), https://www.irs.gov/pub/irs-wd/201428030.pdf. Accordingly, the hospital’s revenues from such activity are not taxable under Section 511. Rev. Rul. 85-110 provides that although

the general rule is that the provision of labo-ratory testing services by a tax-exempt hospi-tal to non-patients constitutes unrelated trade or business, unique circumstances may exist whereby such services may further the hospi-tal’s exempt function. Such unique circum-stances may exist if other laboratories are (1) not available within a reasonable distance from the area served by the hospital, or (2) clearly unable or inadequate to conduct tests needed by hospital non-patients. See https://www.irs.gov/pub/irs-tege/rr85-110.pdf.

15 IRS 1984 EO CPE Text, C. Healthcare Orga-nizations, https://www.irs.gov/pub/irs-tege/eotopicc84.pdf.

16 In determining whether a health club activity is an unrelated trade or business, the analysis focuses on whether the activity is substan-tially related to an organization’s exempt pur-pose. In order to be reported as an unrelated business activity, an activity must meet three criteria: (1) it must be a trade or business, (2) it must be regularly carried on, and (3) it must not be substantially related to the accomplish-ment of the organization’s exempt purposes. In the case of health clubs, the substantially related test is the key. Providing recreational facilities to the general public can be an exempt purpose under IRC 501(c)(3) as long as the facilities are available to a wide seg-ment of the community. Similarly, in order to be exempt from UBIT, a health club con-ducted as an activity of an exempt organiza-tion must benefit a significant segment of the local population. The community benefit test is applied on a case by case, community by community basis; in making this determina-tion, the analysis consists of weighing the facts and circumstances of each situation. The same type of analysis also applies when a health club offers various levels of member-ships for different charges. In cases involving some mixture of exempt and unrelated activi-ties, the proper analysis is based on IRC 513(c) and Treas. Reg. 1.513-1(d)(3), which indicate that income from a particular activity may be deemed unrelated even where the activity is an integral part of a larger complex of activities that may be in furtherance of an exempt purpose. This is commonly known as the fragmentation rule. The fragmentation rule provides that, with respect to health clubs that operate as part of a larger exempt organization, the health club is analyzed sepa-rately to determine whether the health club generates unrelated business income; addi-tionally, each health club activity can be fur-ther fragmented so that one health club activity may be deemed to be related to exempt purposes while another health club activity may result in imposition of UBIT. In most cases, community benefit provides the basis for distinguishing exempt fitness centers from their commercial counterparts. See Rich-ardson, Virginia, Darling, Roderick, Fried-lander, Marvin, 2000 EO CPE Text, Part I, Exempt Organizations Technical Topics, A. Health Clubs, https://www.irs.gov/pub/irs-tege/eotopica00.pdf.

17 ACOs were initially designed for groups of physicians, hospitals and other healthcare providers to deliver coordinated high-quality care to Medicare patients via the Medicare Shared Savings Program “(MSSP”). The MSSP was established by PPACA to improve quality of care for Medicare beneficiaries and


Impact of the Tax Cuts and Jobs Act of 2017 on Tax-Exempt Hospitalscontinued from page 23

reduce unnecessary costs. PPACA also included provisions to use Medicare to broadly implement ACO models to change incentives for how medical care is delivered and paid for by moving away from a system rewarding quantity of services to one rewarding improv-ing health outcomes. Since their inception in 2010, ACOs have expanded in scope to include Medicaid and private insurance arrangements, i.e. ACO non-Shared Savings Programs. ACOs conducting both MSSP and non-MSSP activities must be cognizant of unrelated business income implications for their tax-exempt hospital participants. See, Noller, Christine, Community Benefit, Accountable Care Organizations and Popula-tion Health: Tax Implications for ACOs and Nonprofit Hospital Participants, ABA Health Lawyer, (2017), vol. 30, No.2, pages 16-27.

18 Per IRS Fact Sheet-2011-11, absent inure-ment or impermissible private benefit, any shared savings received by a tax-exempt par-ticipant from an ACO would derive from activities substantially related to the perfor-mance of the charitable purpose of lessening the burdens of government. The IRS further recognized that certain non-Shared Savings Program activities may be related to the exer-cise or performance of a charitable purpose. For example, an ACO’s activities related to serving Medicaid or indigent populations might further the charitable purpose of reliev-ing the poor and distressed or the underprivi-leged. Whether an ACO’s activities that are not substantially related to a charitable pur-pose will generate unrelated business income for its tax-exempt participants will depend on a number of factors. For example, certain kinds of income from the ACO, including dividends and interest, may be excluded from unrelated business income under one of the modifications described in Section 512(b) of the IRC. If the ACO is treated as a partner-ship, whether a tax-exempt partner of the ACO will have to include its share of income derived from an activity in unrelated business income will depend on such factors as whether the activity constitutes a trade or business, is regularly carried on, or is specially excluded from the definition of an unrelated trade or business under Section 513 of the IRC. See https://www.irs.gov/pub/irs-news/fs-2011-11.pdf.

19 Rev. Rul. 2004-51 involved an ancillary joint venture and addressed two issues. The first was whether an organization continued to qualify for exemption from federal income under Section 501(c)(3) when it contributed a portion of its assets to and conducted a por-tion of its activities through an LLC formed with a for-profit corporation. The second was whether the organization was subject to UBIT under Section 511 on its distributive share of the LLC’s income. The revenue ruling involved a tax-exempt university that formed a domestic LLC with a for-profit company that specialized in conducting interactive video programs. The sole purpose of the LLC was to offer teacher training seminars at off campus locations using interactive video tech-nology. The facts established that the univer-sity’s activities conducted through the LLC constituted a trade or business that was

substantially related to the exercise and per-formance of the university’s exempt purposes and functions. Although the for-profit com-pany arranged and conducted all aspects of the teacher training seminars, the university alone approved the curriculum, training mate-rials and instructors and determined the stan-dards for successfully completing the seminars. All contracts entered into by the LLC were at arm’s length and for fair market value. The university’s and for-profit organization’s own-ership interests in the LLC were proportional to their respective capital contributions. All returns of capital, allocations and distributions by the LLC were proportional to the universi-ty’s ownership interests. The fact that the for-profit organization selected the locations and approved the other personnel necessary to conduct the seminars did not affect whether the seminars were substantially related to the university’s educational purposes. The teacher training seminars the LLC conducted using interactive video technology covered the same content as the seminars the university con-ducted on its own campus. The LLC’s activi-ties expanded the reach of the university’s teacher training seminars to individuals who otherwise could not be accommodated at the university’s main campus. The manner in which the LLC conducted the teacher training seminars contributed importantly to the accomplishment of the university’s educa-tional purposes. The activities of the LLC were substantially related to the university’s educational purposes pursuant to Treas. Reg. 1.513-1(d)(2). The university was not subject to UBIT under Section 511 on its distributive share of the LLC’s income. See https://www.treasury.gov/press-center/press-releases/ Documents/js1516_revenueruling200451.pdf.

20 IRC Section 141(a) provides that the term “private activity bond” includes any bond issued as part of an issue that meets the pri-vate business use test of Section 141(b)(1) and private security test of Section 141(b)(2) or meets the private loan financing test of Section 141(c).

21 Under IRC Section 145(a), a qualified 501(c)(3) bond means any private activity bond as part of an issue if all property to be provided by the net proceeds of the issued is owned by a Section 501(c)(3) organization.

22 Under Section 1.150-1(d)(1) of the Treasury Regulations, a refunding bond issue is an issue the proceeds of which are used to pay princi-pal, interest, or redemption price on another issue (a prior issue), as well as the issuance cost, accrued interest, or capitalized interest on the refunding issue, a reserve or replace-ment fund, or any similar costs properly allo-cable to that refunding issue. Current and advance refunding issues are distinguished as follows: Current Refunding Issues: a refunding issue that is issued not more than 90 days before the final payment of principal (e.g., the redemption date) or interest on the prior issue. Advance Refunding Issues: a refunding issue that is issued more than 90 days before the final payment of principal (e.g., the redemption date) or interest on the prior issue. Publication 4078, Tax-Exempt Private Activity Bonds, IRS Office of Tax Exempt

Bonds, 2016, page 4, https://www.irs.gov/pub/irs-pdf/p4078.pdf.

23 IRC Section 149(d)(5), https://www.law. cornell.edu/uscode/text/26/149.

24 IRC Section 149(d)(3).25 IRC Section 149(d)(2).26 Section 3602 of the TCJA (Section 13532 of

the Senate amendments) amends IRC Sec-tion 149(d)(1) to provide that nothing in Section 103(a) or any other provision of law shall be construed to provide an exemption from federal income tax for interest on a bond issued to advance refund another bond. The Tax Cuts and Jobs Act of 2017, Joint Explana-tory Statement of the Committee Confer-ence, supra, page 311.

27 A key difference between the Senate and House bills is that the Senate version pre-served tax-exempt municipal bond financing for capital projects undertaken by non-profit hospitals and other qualifying non-profit orga-nizations. Healthcare organizations were also pleased that the Senate bill, unlike the House bill, preserved the tax deduction for house-holds with high medical expenses, including long-term care costs. See Meyer, Harris, Sen-ate Tax Bill Preserves Most Tax-Exempt Financing for Hospitals, Unlike House Plan, Modern Healthcare, November 10, 2017, http://www.modernhealthcare.com/article/ 20171110/NEWS/171119975.

28 Social determinants of health generally encompass the social and physical environ-ment and health services. They include income and wealth, family and household structure, social support and isolation, educa-tion, occupation, discrimination, neighbor-hood conditions and social institutions. McGovern, Laura, Miller, George, Hughes-Cromwick, Paul, Health Policy Brief, Contri-bution of Multiple Determinants to Health Outcomes, Health Affairs, August 21, 2014, https://healthaffairs.org/do/10.1377/hpb2014 0821.404487/full/healthpolicybrief_123.pdf. Health related social needs, i.e. social deter-minants of health, affect individuals’ health outcomes to a large extent. They also can affect health outcomes and payments for health systems. While a top-rated hospital might be highly effective at treating an acute health issue, the patient’s condition could deteriorate when he returns home to an unhealthy environment. Challenges might include unstable housing situations, difficulty paying utility bills, inadequate transportation to purchase healthy foods, food insecurity or violence in the patient’s home. All of these factors can contribute to the patient’s even-tual return to the hospital for declining health, making it difficult for hospitals to receive incentives and/or avoid financial pen-alties from initiatives such as the Centers for Medicare & Medicaid Services (“CMS”) Hos-pital Readmissions Reductions Program. A 2017 survey of 300 hundred hospitals and health systems revealed that most hospitals (72%) report not having dedicated funds to address social needs for all of their target pop-ulations. Researchers’ qualitative interviews confirmed that sustainable sources of funding


to address social needs is a challenge for many hospitals. One reason for this, per interview-ees, is shifting priorities of federal and state government. See Josh Lee and Casey Korba, Social Determinants of Health: How are Hos-pitals and Health Systems Investing In and Addressing Social Needs?, Deloitte Center for Health Solutions, 2017, https://www2.deloitte.com/content/dam/Deloitte/us/Documents/ life-sciences-health-care/us-lshc-addressing-social-determinants-of-health.pdf.

29 Daly, Rich, Tax-Exempt Bonds Preserved in Final Tax Bill, HFMA Business News, December 19, 2017, http://www.hfma.org/Content. aspx?id=57421.

30 IRC Section 142, https://www.law.cornell.edu/uscode/text/26/162.

31 Treas. Reg. 1.162-7(b)(3), https://www.law.cornell.edu/cfr/text/26/1.162-7.

32 Section 510(c)(3) provides for the exemption from federal income tax of corporations orga-nized and operated exclusively for charitable, scientific or educational purposes if no part of the organizations earnings inures to the bene-fit of any private shareholder or individual. See https://www.law.cornell.edu/uscode/text/26/501. Treas. Reg. 1.501(c)(3)-1(d)(1)(ii) provides that an organization is not orga-nized or operated exclusively for exempt pur-poses unless it serves a public rather than a private interest. To meet the requirement, it is necessary for an organization to establish that it is not organized and operated for the bene-fits of private interests. See https://www.law.cornell.edu/cfr/text/26/1.501%28c%29% 283%29-1.

33 IRC Section 4958 imposes “intermediate sanctions” upon Section 501(c)(3) organiza-tions, in lieu of exemption revocation, as an excise tax on any excess benefit transaction between the exempt organization and a dis-qualified person. See Section 4958(a), (c). The initial penalty is 25 percent of the excess benefit. It is imposed on the disqualified per-son, not the organization. Lesser penalties also may be imposed on one or more of the organi-zation’s managers who knowingly permit the organization to engage in any excess benefit transaction, per Section 4958(a)(2). The dis-qualified person may be liable for the addi-tional second tier of 200 percent of the excess benefit if the violation is not corrected within

a specified period of time, in accordance with Section 4958(b). Correction essentially means undoing the excess benefit to the extent possible, e.g., restoring the organiza-tion to a financial position no worse than it would have been in if the disqualified person had been dealing under the highest fiduciary standards per Section 4958(f)(6), Treas. Reg. 53.4958-1(c)(2). See, Fishman, James, Schwarz, Stephen, Taxation of Nonprofit Organizations, Cases and Materials, 3rd Edi-tion, 2010, pages 231-232.

34 Section 13602 of the TCJA (Section 3802 of the House bill and Section 13602 of the Sen-ate amendments) amended Subchapter D of chapter 42, i.e. the IRC, by adding Section 4960 imposing a tax for remuneration paid by an applicable tax-exempt organization for the taxable year with respect to employment of any covered employee in excess of $1 million plus any excess parachute payment paid by such organization to any covered employee. A covered employee is an employee of an appli-cable tax-exempt organization if the employee is one of the five highest compensated employ-ees of the organization for the taxable year or was a covered employee of the organization (or any predecessor) for any preceding taxable year beginning after December 31, 2016.

35 In the case of any publicly held corporation, no deduction (from corporate income of ordi-nary and necessary expenses per IRC Section 162(a)) shall be allowed for applicable employee remuneration with respect to any covered employee to the extent that the amount of such remuneration for the taxable year with respect to such employee exceeds $1 million in accordance with IRC Section 162(m) See https://www.law.cornell.edu/uscode/text/26/162.

36 No deduction (from corporate income) is allowed for any excess parachute payment, i.e. any payment equal to the excess of any para-chute payment over the portion of the base amount allocated to such payment. See Sec-tion 280G(a) and (b)(1), https://www.law. cornell.edu/uscode/text/26/280G.

37 The term “wages” means all remuneration for services performed by an employee for his employer, including cash value of all remuner-ation (including benefits) paid in any medium other than cash, IRC Section 3401(a), https://www.law.cornell.edu/uscode/text/

26/3401. But for purposes of IRC Section 4960, wages do not include any designated Roth contribution. A designated Roth contri-bution is any elective deferral which is excludable from gross income of an employee (without regard to Section 402A) that the employee designates as not being excludable from income. See IRC Section 402A(c), https://www.law.cornell.edu/uscode/text/ 26/402A.

38 For the purposes of this provision, a covered employee is an employee (including any for-mer employee) of an applicable tax-exempt organization if the employee is one of the five highest compensated employees of the organi-zation for the taxable year or was a covered employee of the organization (or a predeces-sor) for any preceding taxable year beginning after December 31, 2016.

39 Under the provision, an excess parachute pay-ment is the amount by which any parachute payment exceeds the portion of the base amount allocated to the payment. A para-chute payment is a payment in the nature of compensation to (or for the benefit of) a cov-ered employee if the payment is contingent on the employee’s separation from employ-ment and the aggregate present value of all such payments equals or exceeds three times the base amount. The base amount is the average annualized compensation includible in the covered employee’s gross income for the five taxable years ending before the date of the employee’s separation from employ-ment. Parachute payments do not include payments under a qualified retirement plan, a simplified employee pension plan, a simple retirement account, a tax-deferred annuity, or an eligible deferred compensation plan of a state or local government employer. See Tax Cuts and Jobs Act of 2017, Joint Explanatory Statement of the Committee Conference, supra, page 348.

40 Section 457(f)(3)(B) applies to ineligible deferred compensation subject to Section 457(f) [relative to deferred compensation plans of state and local governments and tax-exempt organizations], https://www.law. cornell.edu/uscode/text/26/457.

41 Tax Cuts and Jobs Act of 2017, Joint Explan-atory Statement of the Committee Confer-ence, supra, page 349.

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Chris Haney, CPA, CFE, CHC Forensus Group LLC Richmond, VA

David J. Pivnick, Esq. Erin E. Dine, Esq. McGuireWoods LLP Chicago, IL

IntroductionThe use of statistical sampling

and extrapolation is a growing trend in healthcare legal matters, and it has become a leading tool in the struggle for efficiency when collecting evi-dence. Many courts have accepted statistical sampling and extrapolation as evidence to estimate damages, and administrative agencies routinely use statistical sampling to determine overpayment amounts. Nevertheless, the acceptance of sampling to estab-lish elements of liability in False Claims Act (“FCA”) litigation is openly disputed among counsel, and its evidentiary merit has led to a still-unresolved split among the courts.

Multiple recent federal court decisions have addressed the issue of extrapolating liability in FCA mat-ters, with the majority involving alle-gations against skilled nursing and hospice providers. This article will provide a summary of these recent rul-ings along with a discussion of future implications for the use of extrapola-tion evidence. It will also offer an overview of statistical sampling and technical arguments related to its use in demonstrating FCA liability, with specific attention to the extrapolation of issues involving medical judgment.

Specifically, this article will address four recent FCA decisions: United States ex rel. Martin v. Life Care Centers of America, Inc., United States ex rel. Paradies v. AseraCare, Inc., U.S.

ex rel. Wall v. Vista Hospice Care, Inc., and United States ex rel. Michaels v. Agape Senior Cmty., Inc. Each of these decisions analyzed the use of statistical sampling as it related to patient eligi-bility for hospice and/or skilled nursing care and clinical decision-making. In each case, the government alleged that the provider submitted fraudulent claims to Medicare as part of a scheme to provide medically unnecessary ser-vices. The alleged schemes involved improperly admitting or re-certifying patients who failed to meet appro-priate reimbursement eligibility for hospice and/or skilled nursing care. The government presented specific evidence as to statistical samples of patient admissions in each case, and with those samples, it sought to extrap-olate both liability and damages as to the larger populations of patient admis-sions. As this article will discuss, these rulings reached different conclusions about the admissibility of extrapola-tion evidence for the purposes of proving liability.

Sampling OverviewStatistical sampling analysis is

most commonly used when one seeks to infer useful information about a relatively large population, without examining every unit in the popula-tion, through the examination of only a subset of that population (i.e., a sample). As part of sampling analysis, estimation or extrapolation is a proce-dure by which measured characteris-tics of a sample yield estimates, inferentially, about unknown charac-teristics of the population from which the sample was drawn. Sampling methodologies are described at length in textbooks, journals, and various industry guidelines, and are capable of producing useful results when prop-erly applied.1

While a variety of steps exist to properly design, execute, and inter-pret valid sampling analysis, this arti-cle focuses on the key steps at issue in recent legal rulings in FCA cases.2 Despite the narrow focus in this instance, effective sampling demands attention to all steps of the analysis, since poor work in one area may ren-der a study unreliable, even when everything else is performed properly.3

A critical step in properly execut-ing sampling analysis relates to the composition of the sample itself. Since characteristics of a sample will be used to infer characteristics of the broader population, a sample should be rea-sonably representative of the popula-tion. Specifically, “a representative sample contains all of the attributes of the population in the same propor-tion that they exist in the population. This allows one to generalize from the sample to the population.”4 Con-versely, if the sample chosen is not representative of the population, inferences about the population may be irreparably biased and invalid. The methodology anticipated to lead to a representative sample is random sample selection. Without using proper randomization to select a sam-ple, the presence of selection bias may prevent a sample from being reason-ably representative.5

Another key step in sampling analysis is the measurement of sam-pled units (i.e., the testwork). In healthcare cases, this might involve evaluating whether a sampled patient was treated appropriately, and whether the treatment was coded and submit-ted for reimbursement appropriately. Whatever the goals of a given sample analysis, it is critical that the parties conducting this analysis are objective and do not offer biased or subjective conclusions about each sampling unit.

EXTRAPOLATING LIABILITY – AN ANALYSIS OF THE POTENTIAL USE OF SAMPLING TO ESTABLISH LIABILITY IN FALSE CLAIMS ACT CASES



Such bias has a technical term: error in measurement, and it may inject undue error, or even invalidate an analysis entirely.6 In an effort to pre-vent such bias, analysts strive to ensure reliable, relevant and repeat-able assessments of the data set, and they often work with evaluators to document and standardize their deci-sion-making criteria.

Considerations for Extrapolating Clinical Judgment

A variety of arguments have been developed to refute the use of sampling analysis as evidence of liability in FCA matters. Most significant among the cases discussed in this article is the argument that relators cannot suffi-ciently plead and prove falsity by means of extrapolation. In hospice and/or skilled nursing care cases, this argu-ment generally manifests in one of two variations, with both focusing on the evaluation of medical decision-making:

Objectivity

First, defendants often argue that objective falsity cannot be proven in matters where differences of opinion in clinical decision-making (i.e., sub-jective disagreements about eligibility for hospice and/or skilled nursing care) are the basis for proving false-hood. Said another way, clinical judg-ment has subjective aspects, and the conclusions for each patient in a sam-ple could differ depending on the indi-vidual medical reviewer who reviews the data (i.e., physician, nurse, etc.). In statistical terms, this argument addresses potential measurement error in the analysis (i.e., whether various examiners could or would reach the same conclusions time and time again) and it suggests that a patient’s eligibility for hospice and/or skilled nursing care cannot be measured objectively and reliably, thereby negating the utility of extrapolation.

Notably, this argument is not limited to issues of extrapolation, and

it may be invoked for any claims involving allegations of falsehood due to clinical judgment. However, cases involving sampling often involve a greater number of falsehood claims due to extrapolation and its subse-quent magnifying effect.

Representativeness

Second, defendants often argue that the determination of whether individualized care is medically neces-sary for a particular patient requires an individual assessment of that patient’s physical condition and other patient-specific considerations. Therefore, the assessment of only a subset of individ-ual patients cannot be extrapolated across an entire population. Instead, the argument goes, each patient in the population should be analyzed indi-vidually (i.e., without sampling) to yield accurate conclusions about the total population. The issue raised here is that the decisions rendered for a particular sample might be materi-ally different from those of the entire population. To use statistical termi-nology, this is an issue of the sample’s representativeness.

Both of these arguments enjoy legal as well as statistical merit, and the issues underlying each argument may be so severe from a statistical standpoint, if they do exist in a given sample, to invalidate the entire extrap-olation. However, these arguments have not been universally effective in rebutting the use of statistical sampling in FCA cases. Relators and the gov-ernment routinely argue that the use of sampling and extrapolation is widely accepted in complex litigation, includ-ing FCA matters.7 The government also generally contends that even though unique factors will determine the individual type and amount of therapy received by a patient, such unique factors do not necessarily pre-clude the use of extrapolation as evi-dence. Instead, the government has highlighted that the defendant could challenge the extrapolation through cross examination and competing

witness testimony at trial and that the jury will ultimately decide how much weight to give the evidence.8

Court RulingsThere have been several court

rulings in recent years which have addressed the propriety of using sam-pling to establish liability in FCA cases.9 Some of the most notable recent opinions, which are represen-tative of the analysis on the use of sampling to establish liability, are summarized below:

United States ex rel. Martin v. Life Care Centers of America, Inc.10

In 2012, the federal government intervened in an FCA case against Life Care Centers of America, Inc. (“Life Care”), an operator of over 200 skilled nursing facilities nationwide.11 The government alleged that Life Care engaged in upcoding and pro-vided medically unnecessary, unrea-sonable, and unskilled services, which resulted in the submission of over 150,000 false claims to the federal government.

The government sought to extrapolate from a random sample of 400 admissions from over 80 Life Care facilities from 2006–2012 to estimate the total number of claims (out of the over 150,000 claims) that resulted in overpayments made by Medicare. The defendant subsequently moved for partial summary judgment on the claims for which the government sought to use statistical sampling to prove their falsity.

In a September 2014 opinion, the United States District Court for the Eastern District of Tennessee found that the government could rely on and use sampling and extrapolation to establish not only FCA damages, but actual FCA liability. The court denied the defendant’s motion for summary judgment and found that the government could use statistical sampling to establish the FCA


Extrapolating Liability – An Analysis of the Potential Use of Samplingcontinued from page 27

element of falsity and that if the defendant “wishes to challenge the weight that a fact finder may attribute to the extrapolation, it can employ cross-examination and competing wit-nesses and testimony to highlight the disparity between claims.”12 Notably, the Life Care court allowed statistical sampling to extrapolate claims to show how the defendant’s services were medically unnecessary – a very specific and individualized profes-sional decision that the defendant argued could not be based on statisti-cal sampling and subsequent extrapo-lation. Although the court allowed the government to use statistical sam-pling and extrapolation, Life Care could have still contested the govern-ment’s process and conclusions regard-ing its extrapolation evidence at trial.

Ultimately, in October 2016 the parties agreed to enter into a $145 million settlement.13

United States ex rel. Paradies v. AseraCare, Inc.14

In May 2008, qui tam relators filed a complaint against the defen-dants collectively referred to as “Aser-aCare,” a nationwide operator of hospice facilities, alleging that Asera-Care defrauded the federal govern-ment by driving its employees to liberally interpret patient medical records. Specifically, it was alleged that AseraCare was falsely certifying certain patients as “terminally ill” so as to be eligible for hospice care to enable AseraCare to submit hospice claims for more patients. The federal government intervened in the case, claiming that the submission of false hospice benefit claims constituted a violation of the FCA.

AseraCare filed a motion for sum-mary judgment, challenging the gov-ernment’s use of statistical evidence to demonstrate its claims related to falsely certified hospice services. The government’s expert used a sample of

233 patients from 2,181 claims and determined that approximately half of the claims were “false” under the FCA; the government then sought to extrap-olate the expert’s findings to all 2,181 claims. In December 2014, the United States District Court for the Northern District of Alabama denied the defen-dants’ motion for summary judgment and found that statistical evidence was sufficient to show falsity. The court found that “[s]tatistical evidence is evi-dence,”15 but stated that the jury is to determine the weight to be accorded to the statistical evidence.

In June 2015, after having allowed the government to utilize sta-tistical sampling and extrapolation, the court granted AseraCare’s motion to bifurcate the trial into two phases. The first phase was to determine whether the submitted claims were “false” and the second phase was to decide whether AseraCare knowingly submitted the false claims.

In October 2015, after a two-month trial on the first phase, the jury returned a verdict in favor of the fed-eral government, finding that 104 of the 123 claims that AseraCare had submitted were “objectively” false claims. In November 2015, however, the district court granted the defen-dants a new trial based upon the judge’s belief that improper jury instructions had been provided. In that same November 2015 opinion, the district court questioned whether the government, under the correct legal standard, had “sufficient admissi-ble evidence of more than just a differ-ence of opinion to show that the claims at issue [were] objectively false as a matter of law.”16 Thus, the court found that it would consider a motion for summary judgment to ascertain whether the government could present objective evidence that the claims were false and not just a mere differ-ence of opinion among physicians. In the absence of such objective evidence

of falsity, in March 2016 the court found “that contradiction based on clinical judgment or opinion alone cannot constitute falsity under the FCA as a matter of law” and conse-quently granted summary judgment in favor of AseraCare.17

In May 2016, the federal govern-ment filed a notice of appeal to seek review by the Eleventh Circuit of three orders from the district court involving the court’s decision to bifurcate the trial, an opinion grant-ing the defendants a new trial, and an award of summary judgment to the defendants. The Eleventh Circuit heard oral arguments in March 2017; the appeal is still pending.

United States ex rel. Wall v. Vista Hospice Care, Inc.18

United States ex rel. Wall v. Vista Hospice Care, Inc. involved a qui tam suit filed in April 2007 against Vista Hospice Care, Inc. (“Vista”), an oper-ator of a chain of hospice facilities in 14 states. The qui tam relator alleged that, for a period of time and across multiple Vista facilities, the defen-dants improperly enrolled ineligible patients for hospice care and submit-ted false claims for hospice services provided to beneficiaries who were not eligible for hospice benefits. The complaint also alleged that Vista improperly pressured employees to certify false information regarding hospice eligibility. The government declined to intervene in this case.

In 2016, the United States Dis-trict Court for the Northern District of Texas granted summary judgment in favor of Vista and granted the defendants’ motions to strike the rela-tor’s expert testimony. The court struck the relator’s statistical sampling expert in this case because the court found that statistical sampling was not reliable and could not “establish lia-bility for fraud in submitting claims for ineligible patients, as the underlying


determination of eligibility for hos-pice is inherently subjective, patient-specific, and dependent on the judgment of involved physicians.”19 The court also distinguished the case from AseraCare because the question in Vista Hospice Care was not whether the defendants provided reasonable and necessary services. Rather, the question in Vista Hospice Care was whether, “based on the physician’s or medical director’s clinical judgment regarding the normal course of the individual’s illness a patient had a life expectancy of 6 months or less.”20 This involved scrutinizing the “subjec-tive clinical judgment” of a number of certifying physicians. Therefore, the court found that sampling and extrap-olation in this case could not be used to reliably prove the specific FCA violations that the relator alleged. The court also found that the expert’s process was fundamentally flawed because the chosen sample was not randomly selected and could not be used to infer falsity across the uni-verse of claims.

Vista Hospice Care represents the potential limitations to the use of sta-tistical sampling and extrapolation in FCA cases and provides an example of a situation where extrapolation was not appropriate in an FCA case. The rela-tor has filed a notice of appeal in the Court of Appeals for the Fifth Circuit.

United States ex rel. Michaels v. Agape Senior Cmty., Inc.21

The qui tam relators in United States ex rel. Michaels v. Agape Senior Cmty., Inc. filed their complaint in December 2012 asserting claims against operators of a network of approximately 24 nursing homes throughout South Carolina. The gov-ernment declined to intervene in the case. In March 2014, the relators filed their Second Amended Com-plaint, which alleged that the defen-dants improperly billed federal healthcare programs for hospice ser-vices that were either improperly provided to beneficiaries who were

not eligible for the services or not provided at all.

To establish FCA liability and damages, the relators sought to rely on statistical sampling. The United States District Court for the District of South Carolina, however, found that statistical sampling was improper under the facts and circumstances of the case, mainly because the parties had the ability to review each and every medical record since nothing was “destroyed or dissipated.”22 The district court certified an interlocu-tory appeal of its holdings, including its statistical sampling ruling, and the Fourth Circuit agreed to hear the appeal. The Fourth Circuit had the opportunity to be the first circuit court to clarify and address the statis-tical sampling issue impacting many recent FCA cases. However, the Fourth Circuit ultimately declined to address whether sampling could be used by relators to establish FCA lia-bility after finding that the question was not a “pure question of law.”23 In so ruling, the Fourth Circuit did not provide more definitive guidance for FCA litigants on their ability to rely on statistical sampling. In August 2017, the parties agreed to settle the qui tam case for $275,000.24

Legal Implications of Rulings

The healthcare industry contin-ues to be the most significant target of FCA lawsuits, with the government typically recovering more than half of its annual recoveries from healthcare entities.25 One of the unique aspects of FCA cases in the healthcare con-text pertains to the substantial vol-ume of claims that are submitted annually by healthcare providers. This claims volume will continue to cause relators and the government to pursue the use of sampling to estab-lish damages and, increasingly, to attempt to use sampling to establish liability. However, the potential ben-efits of sampling in terms of efficiency

may be undercut by the inability to account for variances in physician specific decision-making and in comorbidities and other differences between patients.

Moving forward, the issue of sam-pling to establish liability will likely continue to be hotly contested – with relators and the government advocat-ing for such sampling and with defen-dants contesting the propriety of such sampling – until it is resolved by the Supreme Court or by federal circuit courts of appeals.

Statistical Implications of Rulings

For both relators and defendants, these court rulings offer a roadmap for statisticians and analysts to either develop or scrutinize extrapolation analysis. Recall that a variety of steps exist to properly design, execute, and interpret valid sampling analysis. While this article focuses on the key steps at issue in recent legal rulings in FCA cases, effective sampling demands attention to all steps of the analysis, since poor work in one area may render a study unreliable, even when every-thing else is performed properly.26 Below are key considerations of the recent FCA Court rulings regarding the validity and reliability of a sam-pling analysis.

Objectivity

First, an analyst should ensure that the review of sampling units (i.e., the measurement) is, in fact, objective. Parties should be mindful to scrutinize the work plan, testwork criteria, and credentials of all parties involved with the examination and decision making for sampled units. An entirely independent reviewer may reinforce an analysis’ objectivity, along with carefully documenting the criteria by which sampling units are evaluated by the reviewer. For instance, a patient’s eligibility for care should be deter-mined using published medical deci-sion-making criteria, rather than



Extrapolating Liability – An Analysis of the Potential Use of Samplingcontinued from page 29

simply relying on the provider’s sub-jective opinion. Illustrating how the reviewer explicitly considered each criterion and why each patient did or did not meet such criteria can dem-onstrate how a seemingly subjective concept can be, in fact, objective. Alternatively, analysis that is not exe-cuted objectively may inject incur-able subjectivity into extrapolation conclusions, or, at a minimum, intro-duce immeasurable uncertainty into the conclusions of the analysis.

Representativeness

Second, the analyst should dili-gently evaluate the selection and com-position of the sample to ensure that it is randomly selected and, in fact, rea-sonably representative of the popula-tion in question. While sampling units (i.e., patients) may be unique or diverse according to any number of characteristics, the analyst is primarily concerned with characteristics that might affect the measurements of the analysis. For example, foot size might be a unique characteristic for a popula-tion of patients; however, one would not anticipate a selection of patients with disproportionately small feet to be more or less eligible for hospice and/or skilled nursing care. The assess-ment of such irrelevant characteristics, or ignoring otherwise germane criteria, could result in misleading conclusions about a sample’s representativeness.

Instead, the analyst should iden-tify and document the characteristics most believed to affect the measure-ments of a study, and then evaluate whether those characteristics of the sample are reasonably representative of the total population. For instance, characteristics that could impact a patient’s hospice eligibility might include the original physician’s crite-ria for determining eligibility or the facility’s processes and protocols for determining eligibility. Consistent application of such determinations or processes can support an analyst’s

conclusion that a sample is reasonably representative, without which an ana-lyst may be unable to reach objective and valid conclusions.

ConclusionCourts have not reached a defini-

tive determination as to whether sam-pling can be used to establish liability in FCA cases. The propriety of such sampling will depend on patient and physician specific considerations. This will continue to be an important issue to monitor in the future to eval-uate whether there is more definitive guidance rendered as to when sam-pling may be appropriate for purposes of establishing liability.

Chris Haney, CPA, CFE, CHC is a stat-istician and a forensic accountant specializ-ing in healthcare regulatory and compliance matters.

He is a Managing Director of the Forensus Group and he has been admitted and testified as an expert witness in federal court on the topics of statistical sampling and financial damages. Previously, Mr. Haney was a member of the FBI’s Forensic Accounting Unit specializing in complex white collar and healthcare violations. Prior to joining the FBI, Mr. Haney spent five years at General Electric focusing on internal investigations and compliance audits. He may be reached at [email protected].

David J. Pivnick is a partner in McGuireWoods LLP’s Chicago office. His practice is focused on complex commercial litigation

with an emphasis on healthcare litigation. He has represented and advised clients across the country, including hospitals, ambulatory surgery centers,

pharmaceutical manufacturers, and medi-cal device manufacturers in a variety of matters involving the False Claims Act, managed care issues, contract law, restric-tive covenants, trade secrets, injunctive relief, unfair competition, partnership disputes, and products liability. Mr. Pivnick has also provided clients with guidance on compliance issues and conducted internal investigations relating to allegations of False Claims Act viola-tions and other issues. He may be reached at [email protected].

Erin E. Dine is an associate attorney in McGuireWoods LLP’s Chicago office. She practices within the firm’s healthcare department and

advises her clients on a broad range of regulatory, compliance, transactional, and corporate matters. Ms. Dine also handles transactional matters for her clients, representing healthcare providers in joint ventures, mergers, and acquisitions. Her clients include ambulatory surgery centers, dental practices, dialysis centers, hospitals, and physician groups, among others. She may be reached at [email protected].

Endnotes1 reFerence MAnuAl on scientiFic evidence,

3rd edition, FederAl judiciAl center 214 (2011), https://www.fjc.gov/sites/default/files/2015/SciMan3D01.pdf.

2 Christopher L. Haney, Statistical Sampling; Use and Techniques Including RAT-STATS, in HeAltH lAW And coMPliAnce uPdAte (John E. Steiner ed., 2018); see also Overview of Sta-tistical Sampling and Extrapolation: Forensus’ Framework, Forensus GrouP (2017), http://forensus.com/overview-of-statistical-sampling- and-extrapolation/.

3 WilliAM G. cocHrAn, sAMPlinG tecH-niQues 8 (1977).

4 eric e. corty, usinG And interPretinG stAtistics 145 (2007).

5 Id. at 146.6 W. edWArds deMinG, sAMPle desiGn in

business reseArcH 64 (1990); see also steven k. tHoMPson, sAMPlinG 5 (3d ed. 2012).


7 See United States v. Life Care Centers of Am., Inc., 114 F. Supp. 3d 549, 571 (E.D. Tenn. 2014).

8 Id. at 567.9 A person is liable for violating the False

Claims Act (“FCA”) if that person “knowingly presents, or causes to be presented, a false or fraudulent claim for payment or approval [or] knowingly makes, uses, or causes to be made or used, a false record or statement material to a false or fraudulent claim.” 31 U.S.C.A. § 3729(a). Thus, a plaintiff must prove that the (1) defendant made a claim or statement to the government for reimbursement, (2) the claim or statement was false or fraudulent, and (3) the defendant knew that the claim or statement was false or fraudulent.

10 Life Care Centers of Am., Inc., 114 F. Supp. 3d at 549.

11 The FCA allows private citizens, referred to as “relators,” to file suits based on violations of the FCA on behalf of the government. This type of suit is known as a qui tam action. The FCA provides that any qui tam complaint must be first filed with the court under seal. 31 U.S.C.A. § 3730(b)(2). While under seal, the government is required to investigate the alle-gations in the complaint so as to decide whether it will intervene in the applicable FCA case. If the government declines to inter-vene in the FCA case after its investigation, the relator can proceed with the FCA action on his/her own. If the government intervenes, the FCA provides that the relator is entitled to receive at least 15 percent but not more than 25 percent of the amount recovered. Id. at § 3730(d)(1). If the government declines to intervene, however, the relator is entitled to receive between 25 and 30 percent of the amount recovered. Id. at § 3730(d)(2).

12 Id. at 567.

13 Life Care Centers of America Inc. Agrees to Pay $145 Million to Resolve False Claims Act Alle-gations Relating to the Provision of Medically Unnecessary Rehabilitation Therapy Services, u.s. deP’t oF justice (Oct. 24, 2016), https://www.justice.gov/opa/pr/life-care- centers-america-inc-agrees-pay-145-million-resolve-false-claims-act-allegations.

14 U.S. ex rel. Paradies v. AseraCare, Inc., No. 2:12-CV-245-KOB, 2014 U.S. Dist. LEXIS 167970 (N.D. Ala. Dec. 4, 2014).

15 Id. at *10.16 U.S. ex rel. Paradies v. AseraCare, Inc., 153 F.

Supp. 3d 1372, 1385 (N.D. Ala. 2015).17 U.S. ex rel. Paradies v. AseraCare, Inc., 176 F.

Supp. 3d 1282, 1286 (N.D. Ala. 2016).18 United States v. Vista Hospice Care, Inc., No.

3:07-CV-00604-M, 2016 WL 3449833 (N.D. Tex. June 20, 2016), reconsideration denied sub nom. United States ex rel. Wall v. Vista Hospice Care, Inc., No. 3:07-CV-0604-M, 2017 WL 5483747 (N.D. Tex. Nov. 14, 2017.

19 Id. at *11.20 Id. at *12 (emphasis in original) (internal

quotations omitted).21 U.S. ex rel. Michaels v. Agape Senior Cmty.,

Inc., No. 15-2145, 2017 WL 588356 (4th Cir. Feb. 14, 2017).

22 U.S. ex rel. Michaels v. Agape Senior Cmty., Inc., No. CA 0:12-3466-JFA, 2015 WL 3903675, at *7 (D.S.C. June 25, 2015), order corrected, No. CA 0:12-3466-JFA, 2015 WL 4128919 (D.S.C. July 6, 2015), and aff’d in part, appeal dismissed in part sub nom. United States ex rel. Michaels v. Agape Senior Cmty., Inc., 848 F.3d 330 (4th Cir. 2017).

23 Michaels, 2017 WL 588356, at *6. The Fourth Circuit found that review of interlocutory

appeals are not appropriate if the question presented “turns on whether there is a genu-ine issue of fact or whether the district court properly applied settled law to the facts or evi-dence of a particular case.” Michaels, 848 F.3d at 341. The question presented in Michaels v. Agape Senior Community was whether the pro-posed statistical sampling was conducted in a “scientifically proven and accepted manner pursuant to the Supreme Court’s ruling” in Daubert v. Merrell Dow Pharmaceutical. Id. Because the question presented did not “pres-ent a pure question of law that is subject to [the court’s] interlocutory review,” the Fourth Circuit dismissed the statistical sampling aspect of the relator’s appeal. Id.

24 AGAPe litiGAtion ends, deborAH b. bArbier (Aug. 23, 2017), https://dlbjbjzgnk95t.cloud front.net/0957000/957059/press%20statement% 20on%20settlement.pdf. The government had previously rejected a larger settlement of $2.5 million, despite the fact that it did not intervene, demonstrating that the govern-ment still has control over the case as the actual party-in-interest even where it declines to intervene. Brian P. Dunphy & Laurence Freedman, Fourth Circuit Permits DOJ to Reject an FCA Settlement, But Punts Decision on Sta-tistical Sampling, HeAltH lAW & Policy MAtters (Feb. 22, 2017), https://www.healthlawpolicymatters.com/2017/02/22/fourth-circuit-permits-doj-to-reject-an-fca-settlement-but-punts-decision-on-statistical-sampling/.

25 Justice Department Recovers Over $3.7 Billion from False Claims Act Cases in Fiscal Year 2017, dePArtMent oF justice (Dec. 21, 2017), https://www.justice.gov/opa/pr/justice-department-recovers-over-37-billion-false-claims-act-cases-fiscal-year-2017.

26 cocHrAn, supra note 3, at 8.

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