valuing healthcare management services agreements

Valuing Healthcare Management Services

Agreements

April 3, 2014

Prepared for NACVA Webinar

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April 3, 2014


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© 2013 National Association of Certified Valuators and Analysts

3

April 3, 2014


Agenda

2 Management Services Defined

3 Critical Factors in Valuing Management Services

4 Valuation Approaches

Agenda

1 Introduction

2

2 Regulatory Considerations3

4

5

4 Case Studies6

April 3, 2014


Introduction

• Have been in existence in healthcare for decades and historically focused on administrative and/or operational tasks

• Provide hospitals, ambulatory surgery centers (ASCs) and physician practices with operational and functional services

• Common situations where healthcare provider might seek third-party entity for management services

– Provider determines that outsourcing certain management functions will result in optimization of its operations

– As part of an acquisition or joint venture

– One provider seeks to affiliate with another by integrating some level of operations or one party provides expertise and infrastructure to the other

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• Management services or “purchased services” are geared towards strengthening business aspects of an operation– Expertise, cost-efficiency, and economies of scale in business services

• Outsourcing of medical and/or administrative services

Clinical Operational Needs Non-clinical Operational Needs

Medical Directorship Contract Negotiations

Clinical Staff Legal and Financial Services

Clinical Management Risk Management

Billing

Human Resources Support

Operations Management

Management Services Defined

April 3, 2014


• Between “like” provider entities

– Hospital providing management services to another hospital

• Between different types of providers

– Physician practice and a hospital/health system

• Between providers and third parties

– ASC and third-party manager

Types of Transactions

April 3, 2014


• Refer to instances whereby hospital and physicians collaboratively manage and operate a particular hospital service line or program, such as orthopedics, cardiology, or oncology

– Shared vision

– Formal alignment in patient care delivery

– Improved program outcomes

– Enhanced association between hospitals and physicians

– Operational excellence

– Effective decision-making structure

New Trend: Co-Management and Service Line Management Arrangements

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• Accounting & Financial Management

– Budget development

– Internal financial statements

– Billing services

– Managed care contracting

– Malpractice premium negotiation

– Oversight and monitoring

• Operations

– Day-to-day oversight and administration

– Staffing and scheduling

– Equipment and supply procurement

– Policies & procedures

– Regulatory compliance

– Assistance with credentialing

Examples of Management Services

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• Human Resources

– Review of staffing levels

– Recruitment and retention

– Training and orientation

– Appointment and evaluation of clinical and non-clinical staff

• Leadership

– Medical director services

– Medical staff activity participation

– Management and/or advisory committee participation

• Strategic Planning

– Development of strategic plan

– New program development

– Participation in strategic planning process

• Other

– Quality and process improvement

– Patient and community outreach

– Assistance with accreditation

Examples of Management Services

April 3, 2014


Traditionally

• Fixed fee or cost of providing services plus profit factor

• Percentage of net patient revenue (i.e., billing)

• Mark-up percentage on cost (i.e., employee leasing)

Today

Compensation forManagement Services

• Fixed fee based on certain pre-defined services plus

• “At risk” component based on achievement of defined quality outcomes and metrics (i.e., reducing infection rates, attaining patient satisfaction, etc.)

“Traditional” “Modern”

April 3, 2014


Regulatory Considerations

You’re not paranoid -- they really are after you.

April 3, 2014


Regulatory Considerations

• Federal False Claims Act• Federal Anti-kickback Laws (fraud and abuse laws & regs)• Stark Laws (physician self-referral laws & regs)• IRS Private Inurement Regulations (affecting tax-exempt organizations)• State Anti-kickback and Self-referral Laws• Provider-based Status Rules

April 3, 2014


• “The price at which the property or service would change hands between a willing buyer and a willing seller, neither being under a compulsion to buy or sell and both having reasonable knowledge of the relevant facts.” (Estate Tax Reg. 20.2031.1-1(b); Revenue Ruling 59-60, 1959-1, C.B. 237)

• This definition is consistent with the Stark Law definitions of fair market value and general market value, which are defined as follows:

– Fair Market Value: the value in arm’s-length transactions, consistent with the general market value.

– General Market Value: the price that an asset would bring as the result of bona fide bargaining between well-informed buyers and sellers who are not otherwise in a position to generate business for the other party, or the compensation that would be included in a service agreement as the result of bona fide bargaining between well-informed parties to the agreement who are not otherwise in a position to generate business for the other party, on the date of acquisition of the asset or at the time of the service agreement. (Federal Register / Vol. 69, No. 59 / Friday, March 26, 2004 / Rules and Regulations)

Fair Market Value Defined

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Commercial Reasonableness Definition• The Centers for Medicare & Medicaid Services (“CMS”) formerly

interpreted the requirement of ‘commercial reasonableness’ to designate an arrangement appearing to be “a sensible, prudent business agreement, from the perspective of the particular parties involved, even in the absence of any potential referrals.” (63 Fed. Reg. 1700 - Jan. 9, 1998)

• CMS further clarified its intent in subsequent Stark Law commentary which states that “an arrangement will be considered ‘commercially reasonable’ in the absence of referrals if the arrangement would make commercial sense if entered into by a reasonable entity of similar type and size and a reasonable physician (or family member or group practice) of similar scope and specialty, even if there were no potential designated health services (“DHS”) referrals.” (69 Fed. Reg. 16093 - March 26, 2004)

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Fair Market Value

___________________________________________________________________

Cents___________________________________________________________________

Scope: Range of Dollars

OnlyKey Question: “How Much”?

Commercial Reasonableness

___________________________________________________________________

Sense___________________________________________________________________

Scope: Overall Arrangement

Key Question: “Why”?

Compliance Issues Regarding Financial Relationships

Two Components

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Presence of Legal

Agreement

FMV Assessment of Services &

Fees

Define Scope of Services

and Areas of Need

Understand Legal

Structure

• Administrative and operational services • Clinical responsibilities • Incorporation of quality incentives

• Contracts between: Physician group and

hospital Hospital and

management company formed to execute management services

ASC and ASC management company

• Duties and responsibilities• Provision of terms • Termination of agreement• Compensation

• Appraiser with experience in healthcare transactions

• Consideration of other arrangements (i.e., call coverage, medical directorship, physician lease, or leaseback agreements)

• Commercial reasonableness

Critical Factors in ValuingManagement Services

April 3, 2014


• Management arrangements can be valued based on the following approaches:

• Cost Approach: Value indication as if the services were performed internally; involves a calculation of the cost to replace or replicate

• Market Approach: Value as indicated under the principles of a free market, such that supply and demand forces will determine prices of business assets; market data is analyzed to determine what is actually being paid in the marketplace for comparable services

• Income Approach: Value indication determined by the accrued economic benefits of an asset

• Build vs. Buy: Would it be more cost-effective to perform management services internally?

• Yes, Build: Cost Approach

• No, Buy: Market Approach

Valuation Approaches

April 3, 2014


• Gain an understanding of the scope of services - Each agreement has its own unique set of considerations and services- If the agreement is vague, appraiser should interview the hospital’s legal

counsel - Wording of agreements should be taken into careful consideration

- “Assist with billing and collection functions” vs. “perform billing and collections”

• Determine appropriate level of staffing and resources - Nature of company being managed differs greatly (i.e., physician practice vs.

hospital outpatient department)- Historical and projected revenues will impact the level of management

services required- Level of complexity, diversity and comprehensiveness of services will impact

resources required

Cost Approach Considerations

April 3, 2014


• Determine costs of providing services- For required staffing, various salary surveys should be analyzed to determine

appropriate compensation amounts- Differentiate between clinical and administrative duties- Reasonable markups to reflect the risk that the management company is

assuming by employing required staff should be included - Agreements including other services may require additional resources

- If facility space is part of the arrangement, the determination of appropriate markups or fair market value rent should be conducted by a qualified real estate appraiser

Cost Approach Considerations (continued)

April 3, 2014


• Identify market comparable data with similar components or risk profiles as the subject arrangement

- ASCs• Management arrangements are prevalent

• Is the provision of clinical staff included?

• Is the ASC management company a minority owner in the ASC?

- Publicly traded companies providing management services

• Analyze data and make comparability adjustments• Weigh importance of tasks being evaluated against market comps

• Compare risk/responsibility of management company to market comps

• Consider revenue size of market comps to determine whether management fee as a percentage of revenue is appropriate for subject

Market Approach Considerations

April 3, 2014


• Determine the value of the economic benefits that would accrue to either side of the management services arrangement

– To analyze the seller’s benefits, consider the profit level of the management company given the calculated management fee and compare with market-based rates; the amount of the management fee should appropriately reflect the level of risk that is being assumed by the management company

– To analyze the buyer’s benefits, determine the value of the benefits that would accrue to the managed organization from the services provided by the manager (i.e., isolate the financial impact to those results achieved by management company’s efforts) or evaluate the total earnings, margins, and returns of the organization given its purchase of the management services

– Analyses have practical limitations

Income Approach Considerations

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Necessity of Specialized Expertise

Oversight and Monitoring

Legitimacy of the Business Purpose

Appropriateness of Management

Services

• Does the proposed arrangement represent a reasonable necessity for the operation of the managed entity?

• Is the management agreement necessary to further a legitimate business purpose of the managed entity?

• Are the particular duties of the management company clearly defined?

• Are the management services a necessary addition to the managed entity’s current managerial or administrative staff?

• Does the management agreement require the services of physicians or other specialized staff?

• If so, does the management company possess the requisite expertise and experience to perform the management services?

• Is there a written agreement that clearly defines the terms of the agreement?

• Does the managed entity engage in routine monitoring efforts to ensure that the required services are actually performed?

Commercial Reasonableness

April 3, 2014


Project: Assessment of FMV compensation for a potential management services agreement to provide clinic start-up services, administrative and management services, personnel and human resources, and billing services.

• Scope of services: Administrative services

• Type of transaction: Between management company and physician practices

• Presence of legal agreement: 1-year renewable agreement

• FMV assessment of fees: Cost and market approaches

• Compensation: Total annual payment

Case Study #1

April 3, 2014


Project: Assessment of FMV compensation for the co-management of cardiology services between a hospital and physician practice

• Scope of services: Clinical and administrative services

• Type of transaction: Between hospital and physician practice

• Presence of legal agreement: 3 years

• FMV assessment of fees: Cost and market approaches

• Compensation: Fixed fee for provision of defined administrative and medical directorship services with “at risk” payment for achievement of identifiable quality metrics

Case Study #2

April 3, 2014


Contact InformationTynan P. Olechny, MBA/MPH, CVA

Principal, PYA

404-266-9876

[email protected]