Fair Market Value of Physician Compensation Appraisal Theory and Applications Presented by: Randy Biernat, CPA/ABV 1

Fair Market Value of Physician Compensation Appraisal Theory and Applications

Presented by: Randy Biernat, CPA/ABV

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Introduction

•Assumed Knowledge Level

•Types of Arrangements to be Discussed

•Detail Level of Presentation

•Disclaimer

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Healthcare Market Overview

•Consolidation

•Integration

•Healthcare Reform

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Hospital-Physician Arrangements

•Common Hospital Motivations • Create or Expand Access to Services

• Continuity/Coordination of Care

• Market Share / ACO Positioning

• Enhance Patient Experience

• Achieve Efficiencies

• Expanded Clinical Expertise / Branding

• EMTALA or Other Compliance Requirements

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Hospital-Physician Arrangements

•Common Physician Motivations • Opportunity for Profit / Income Stability

• Control or a Voice in Decision Making

• ACO Positioning

• Access to Capital

• Market Positioning

• Co-Branding

• Personal Prestige

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Arrangements Discussed Today

•Medical Direction

•Call Coverage

•Professional Service Arrangements (Leases)

•Co-management Arrangements

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Appraisal Overview1. Determine and Document FMV Requirements,

including Jurisdictional Exceptions

2. Identify Parties to Agreement

3. Document Purpose of Arrangement

4. Identify Method of Compensation

5. Consider and Select Valuation Methodology

6. Evaluate Transaction from the Perspective of Each Party.

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Appraisal Overview7. Reconcile FMV Findings

8. Provide Conclusion of FMV Range of Compensation

The availability of information may limit the appraiser’s ability to complete each of the above steps

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Information Required• Term Sheet / Draft Contract

• Written Summary of Benefits accrued to Facility

• Representations on Relevant Facts Related to the Arrangement

• Financial Impact of Arrangement to Both Parties

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General Guidance• To the extent possible, both parties should sign

off jointly on major assumptions

• Trade offs in quality, timeliness, and believability will dictate whether or not an appraisal can be delivered

• Working closely with qualified counsel will help ensure you are making assumptions and using data consistent with the legal opinion

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Standard of Value• From R.R. 59-60 to “Healthcare FMV”

• Entity to Compensation Valuation

• Implications to Appraisers

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Fair Market Value (R.R. 59-60)

The typical standard of value is classically defined by Revenue Ruling 59-60:

“The price at which property would change hands between a willing buyer and willing seller, neither party being under any compulsion to buy or sell, and both having reasonable knowledge of all relevant facts, with equity to both.”

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Fair Market Value (Stark)“…the value in an arm’s length transactions, consistent with the general market value. ‘General market value’ means the price that an asset would bring, as the result of a bona fide bargaining between well-informed buyers and sellers who are not otherwise in a position to generate business for the other party….” (Stark regulations at 42 CFR § 351)

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Fair Market Value in Management Services Arrangements

• Same standard of value as entity valuation

• “Ultimately, fair market value is determined based on facts and circumstances. The appropriate method will depend on the nature of the transaction, its location, and other factors.” (Federal Register, Vol. 72, No. 171, CMS, 42 CFR Parts 411 and 424)

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Implications of Stark Standard of Value

• Avoid “investment value” • No consideration of downstream referrals

• No consideration of hospital rates

• No consideration of specific economies of scale

• Limitations on use of opportunity cost

• Deal must make sense between purely arms’-length players

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Valuation Methodologies

• Survey Benchmarking

• Cost Mark-up

• Management Company Fee Benchmarking

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Methodologies: Survey Benchmarking

Description – Survey benchmarking captures the range of compensation paid for labor and other goods and services in the marketplace.

Application – By benchmarking the subject arrangement to market pricing, one can infer fair market value (especially if benchmark data is not referral based).

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Limitations – Survey data may not capture entity risk and is not available for certain goods and services.

Cautions – Careful matching of service type to survey data may call for adjustments to make an appropriate comparison (independent contractor status, etc.).

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General Guidelines

•Compensation commensurate with productivity

•Consider isolating clinical and non-clinical sources of income

•Be cautious with utilizing compensation per WRVU survey data

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General Guidelines, cont.

•Signing & Retention bonuses

•Student loan repayments

•Malpractice insurance tail coverage

•Outside income

•Multiple contractual arrangements

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Sources of Data

•MGMA

•Sullivan Cotter

•Watson Wyatt

•IHS Survey

•Many others

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Methodologies: Cost Mark-up

Description – Cost mark-up approaches seek to determine and apply a profit to the costs of the goods and services to be provided on a risk adjusted basis.

Application – Discrete cost pools must be determined by type and care must be taken that mark-ups appropriately match services.

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Limitations – Ascribing value to costs may create an incentive to increase costs and the methodology may fail to recognize the value of efficiencies.

Cautions – Markups should be applied to discrete pools of costs to avoid double dipping.

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Guidelines

•What is really being received by the purchaser?

•Confusing cost of capital and acceptable rate of return

•Adjusting for risk

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Sources of Data

•Publicly-traded companies

•Private transaction data

•Freestanding surveys, such as MGMA’s ASC Survey

•Risk Management Association

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Methodologies: Management Fee Benchmarking

Description – A percentage of facility revenues is used for a fee to be paid for a contractual bundle of goods and services.

Application – A determination is made that the services under consideration for FMV has a sufficient match to market data that a pricing inference can be drawn and relied upon.

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Limitations – Benchmark data is typically unclear as to what goods and services are included in an arrangement, which can create matching issues.

Cautions – Assumptions utilized in drawing comparisons on rates will need to be reasonable in order to support this approach.

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Guidelines

•Traditional management companies typically exclude medical director fees

•Not all fees necessarily tie to specific costs• Base fee – tied to hours worked

• Incentive fee – based on good results

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Sources of Data

•Ancillary business survey data (such as surgery center or imaging center cost data)

•Perform survey of management company fees

•Private transaction database(s)

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Comparison of Approaches

MethodologyPrimary Method

Secondary Method

Commercial Reasonableness

Survey Benchmarking

Yes Yes Yes

Cost Mark-up Yes Yes Yes

Before & After Analysis

No No Yes

Management Co. Benchmarking

Yes Yes Yes

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Framework for Valuation• Medical Direction

• On-Call Arrangements

• Professional Services Agreements

• Co-Management Arrangements

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Medical Direction

Overview • Hospital engages a physician to provide unique

clinical insight necessary for hospital operations, accreditation, management, etc.

Typical Valuation Methodologies• Survey Benchmarking• Sullivan Cotter, HIS, MGMA, etc.

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Medical Direction

Going One Level Deeper• Look for a good understanding of duties to

determine what data should be used

• Executive Services versus Traditional Directorships

Signs of a Bad Deal• Numerous directorships with apparent overlap

• Services provided are unnecessary/undocumented

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On-Call Arrangements

Overview • Hospital engages a physician or physician group

to provide guaranteed clinical coverage at its facility(s)

Typical Valuation Methodologies• Survey Benchmarking• Sullivan Cotter

• MGMA

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On-Call Arrangements

Going One Level Deeper• Unrestricted versus Restricted

• Call Burden / Trauma Designation of Facility

• Uncompensated Care

Signs of a Bad Deal• Services are not exclusive (stacked services)

• Services to be provided are unnecessary

• Fees are based on clinical opportunity cost35

Professional Services Agreements

Overview • Hospital engages a physician or physician group

to provide clinical services on its behalf while physician remains an independent contractor

Typical Valuation Methodologies• Survey Benchmarking • Compensation surveys (Sullivan Cotter, MGMA, etc.)

• Cost Mark-up

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Professional Services Agreements

Going One Level Deeper• What else is included besides physician services?

• Exclusion of Designated Health Services

• Use of physician extenders

Signs of a Bad Deal• The payment rate is not reconciled properly to

services included in the arrangement

• Fees based on practice overhead37

Co-Management Arrangements

Overview • Hospital engages a physician-owned entity to provide

management services on its behalf for some component of its inpatient or outpatient services

Typical Valuation Methodologies• Cost Mark-up (primary)

• Survey Benchmarking (primary)

• Profit Margin Analysis & Before and After (secondary)

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Co-Management Arrangements

Going One Level Deeper• Breakdown of the Technical Component is

Crucial

• Consideration of Provider-based Rules

• Bona Fide Services

Signs of a Bad Deal• Looks like a billing under arrangement

• Fees are based entirely on a percentage of revenue39

Case Studies• Co-management Arrangement

• On-call Coverage Arrangement

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Co-Mgmt. Case Study - Facts• Hospital seeks to align with a group of

orthopedic surgeons to develop a Spine Institute (SI).

• Hospital believes the development of a SI will greatly increase patient access and improve care coordination with its substantial employed primary care physician group.

• Hospital has a not for profit tax status.

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Co-Mgmt. Case Study - Facts• Hospital believes the involvement of

community physicians in the development of its SI is critical to the clinical success of the program and in its marketing efforts to the community.

• Therefore, Hospital proposes a co-management arrangement with a small group of spine surgeons.

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Co-Mgmt. Case Study – Facts• Hospital proposes the Management Company

to provide the following:– Executive Medical Direction (250 hours per year)

– Traditional Medical Direction (Clinical Protocol Development, Implementation, Staff Orientation, Management, Training, Program Development and Community Outreach (400 hours per year)

– Non-Physician Executive Director

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Co-Mgmt. Case Study – FMV Analysis

Survey Method

Executive Administrative M.D. Hours 250 Executive Administrative M.D. Hourly Rate 300 Total Executive M.D. Compensation 75,000

Traditional Administrative M.D. Hours 400 Traditional Administrative M.D. Hourly Rate 175 Total Administrative M.D. Compensation 70,000

Non-Physician Service Line Director 155,000

Total Management Company Compensation 300,000$

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Mark-up Method

Allocated M.D. Cost (650 hours @ $200) 130,000 Executive Director Cost 130,000 Labor Cost Pool 260,000

FMV Labor Mark-up Factor (35% gross margin) 1.54 Total Management Company Compensation 400,000

Mgmt Co. Profit 140,000 Gross Profit Margin 35%

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Management Company Benchmarking

Management Fee as a % of Normalized Revenue 4.5%

Pricing for Non-MD Management Companies 2.5% - 6.5%Private Transaction Database Pricing 3.5% - 8.5%

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Co-Mgmt. Case Study – ConclusionSummary of FMV Results

Proposed Compensation 400,000$

Survey Method 300,000 consistent with FMV

Mark-up Method 400,000 consistent with FMV

Mgmt Co. Fee Benchmarking 2.5% - 8.5% consistent with FMV

or 4.5% of collections

Overall Arrangement is Fair Market Value

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On-Call Coverage Case Study – Facts• Hospital has an identified need to provide

more consistent general surgery trauma coverage as its recent ER expansion has yielded more acute cases than anticipated.

• Hospital does not employ any general surgeons trained to treat trauma cases and cannot otherwise convince qualified surgeons to volunteer to provider necessary coverage.

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On-Call Coverage Case Study – Facts• Hospital believes the engagement of qualified

trauma surgeons will improve patient outcomes and enhance its reputation in the community.

• Therefore, hospital agrees to pay a pool of five local general surgeons qualified in trauma surgery a fair market value rate for 24/7/365 coverage of its emergency department.

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On-Call Coverage Case Study - Facts• Hospital proposes the physicians to provide

the following services:– Unrestricted (“beeper”) call with a phone response

time of 10 minutes and on-site consultation within 30 minutes, as necessary, and a named back-up

– Other terms include a penalty for failure to respond, a fmv re-evaluation provision, an evergreen clause, a statement of the physicians’ right to bill for services rendered while on call, etc.

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On-Call Case Study – FMV Analysis

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Category Applicable FactsFMV

Impact

M.D. Supply and Demand Area has limited trauma surgeons ↑

Frequency of Call Low call volume expected in yr. 1 ↓

Use of Backup Expected to be low ↑

Payor Mix of Patient Seen ED has poor payor mix ↑

Facility Trauma Designation Currently applying for level two status --

Depth of Call Rotation 1 in 5 --

Other Facts Hospital is in a high crime urban area ↑

Facts and Circumstances Matrix


Survey Method25th 50th 75th

Trauma Surgery Daily Rate 575$ 950$ 1,200$

Market Method Rate

Local Market Deal A 600$ similar in scope and intensity

Local Market Deal B 800$ Subject agmt is less intense

Regional Market Deal C 1,100$ Subject agmt is less intense

Facts and Circumstances Comparison

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Synthesis of MethodsLow High

Published Survey Data 500$ - 1,000$

Proposed Daily Rate 650$

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Overall Arrangement is Fair Market Value

Questions & Answers

Contact Information

Randy Biernat, CPA/ABV

BKD, LLP

Direct: 317-383-4271

Email: [email protected]

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Documents

Fair Market Value of Physician Compensation Appraisal Theory and Applications Presented by: Randy Biernat, CPA/ABV 1