PYA Presents Intro to Healthcare Valuation

transcript

#AICPA_HEALTH

Healthcare Valuation 101AICPA National Health Care Industry ConferenceNovember 13, 2013

American Institute of CPAs 2#AICPA_HEALTH

Speaker Biography – W. James Lloyd, CPA/ABV, ASA, CFE

AICPA National Healthcare Industry ConferenceValuation 101Agenda and Timeline

Introduction

Fair Market Value• Revenue Ruling 59-60• International Glossary of Business Valuation Terms• Stark Law definition of FMV:

- Assets- Service agreements- Equipment leases- Space rental

CMS commentary on FMV compensation

Federal Anti-Kickback safe harbors:• Space rental• Equipment rental

IRS definition of reasonable compensation

Healthcare Laws and Case Law Update

Anti-Kickback statute and regulations:• Section 1128B of the Social Security Act prohibits the offering,

paying, soliciting or receiving of any remuneration to induce or to reward referrals of items or services payable by federal healthcare programs, including Medicare and Medicaid. [42 U.S.C. §1320a-7b(b)]

• Covers referrals for any item or service that might be paid for by Medicare or any other federal healthcare program

• Provides for criminal liability to both sides of an illegal transaction, even where only one purpose of the remuneration offered, paid, received, etc., is to obtain money in exchange for referrals or to induce referrals

United States v. Kats and United States v. Greber interpreted the Anti-Kickback statute as being violated if only one purpose of the remuneration is to pay for a referral of goods or services, or to encourage or induce referrals, even if another purpose of the payment is to compensate the individual for professional services or the payment serves another legitimate purpose. [871 F.2d 105 (9th Cir. 1989); 760 F.2d 68 (3d Cir. 1985), cert. denied, 474 U.S. 988 (1985)]

Section 6402(f) of the Patient Protection and Affordable Care Act (“PPACA”) added the following two sub-sections to the Anti-Kickback statute:• Claims for items and services provided to federal healthcare

program beneficiaries that violate the Anti-Kickback statute constitute false or fraudulent claims for purposes of the Civil False Claims Act [42 U.S.C. §1320(a)-7b(g)]

• A person does not need actual knowledge of the Anti-Kickback statute or specific intent to violate the Anti-Kickback statute [42 U.S.C. §1320(a)-7b(h)]

Key Anti-Kickback Statue (“AKS”) safe harbors: [42 CFR §1001.952]• Investment interests• Space rental• Equipment rental• Personal service and management contracts• Sale of a practice• Employees• Practitioner recruitment• Obstetrical malpractice insurance subsidies• Investments in group practices• Ambulatory surgical centers

Emphasis of FMV in AKS safe harbors:• Investment interests• Space rental• Equipment rental• Personal service and management contracts• Increased coverage, reduced cost-sharing amounts, or reduced

premium amounts offered by health plans• Ambulatory surgical centers (pre-operational services)• Price reductions offered by contractors with substantial financial

risk to managed care organizations• Ambulance replenishing

Examples of additional AKS compliance guidance:• 1992 Letter from D. McCarty Thornton (“Thornton Letter”)• Selected OIG Advisory Opinions

- Advisory Opinion 07-05- Advisory Opinion 07-10, 09-05, 12-15- Advisory Opinion 12-22- Advisory Opinion 09-09, footnote 5

• OIG Special Fraud Alerts- February 24, 2000: Rental of office space

• OIG Special Advisory Bulletin- June 2001: Practices of Business Consultants- “A valuation consultant promising or assuring a client that its

appraisal of a physician’s practice will yield a “fair market value” that satisfies the client’s need for a particular valuation, regardless of the actual value of the practice.”

Stark Law• Stark statute

- The federal physician self-referral prohibition (“Stark Law”) prohibits a physician from referring Medicare patients for designated health services (“DHS”) to an entity with which the physician, or the physician’s immediate family member, has a financial relationship, unless the relationship meets the specific requirements of a Stark exception. [42 U.S.C. §1395nn]

- Prohibits the entity from submitting a claim (or causing a claim to be submitted) to Medicare

- “Financial relationships” include both ownership and compensation relationships.

- Strict liability statute – no intent to violate necessary

Designated Health Services (“DHS”): [42 CFR §411.355]• Clinical laboratory services• Physical therapy, occupational therapy, and outpatient speech-

language pathology services• Radiology and certain other imaging services• Radiation therapy services and supplies• Durable medical equipment and supplies• Parenteral and enteral nutrients, equipment, and supplies• Prosthetics, orthotics, and prosthetic devices, and supplies• Home health services• Outpatient prescription drugs• Inpatient and outpatient hospital services

Common Stark exceptions:• General exceptions to both ownership and compensation:

[42 CFR §411.355]- Physician services- In-office ancillary services- Academic medical centers

• Exceptions related to ownership or investment interests: [42 CFR §§ 411.352 and 411.356]- Physician-owned hospitals

- ACA prohibitions- Grandfathered hospitals and expansion prohibitions

Common Stark exceptions, cont’d:• Exceptions related to compensation arrangements:

[42 CFR §411.357]- Rental of office space- Rental of equipment- Bona fide employment- Personal service arrangements- Physician recruitment- Isolated transactions- Fair market value compensation- Indirect compensation arrangements- Obstetrical malpractice insurance subsidies- Retention payments in underserved areas

CMS Advisory Opinions• Social Security Act requires that CMS issue written advisory

opinions on the Stark Law• These opinions provide guidance on whether a physician's

referrals for DHS payable by Medicare to an entity with a financial relationship are prohibited under Stark.

• Advisory opinions available to the general public at www.cms.gov

• Provides a binding opinion on the application of Section 1877 to specific factual situations

Key Stark compliance concepts:• Fair market value

- Academic Medical Center exception- Rental of office space- Rental of equipment- Bona fide employment relationships- Personal service arrangements- Isolated transactions- Group practice arrangements with a hospital- Payments by a physician- Fair market value compensation- Indirect compensation arrangements

Key Stark compliance concepts: cont’d• The Stark regulations define fair market value as “the value in

arm’s length transactions, consistent with the general market value;” and general market value is defined as “the price that an asset would bring as the result of bona fide bargaining between well-informed buyer and sellers who are not otherwise in a position to generate business for the other party, or 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 the acquisition of the asset or at the time of the service agreement.” [42 CFR 411.351]

Key distinction in the FMV definitions:• The Stark definition prohibits consideration of the parties’

positions to generate business for one another.• Taking into account the ability to generate referrals can result in

FMV outside the healthcare industry, but is a fatal valuation error under Stark.

Key Stark compliance concepts, cont’d:• Set in advance: [42 CFR §411.354(d)]

- Formula set forth in sufficient detail- Objectively verifiable- Not changed during the course of the agreement based on

referrals or other business generated- Unit-based compensation must be FMV and does not vary

based on referrals of DHS- CMS favorably considers percentage-based formulas for

personally performed services

Key Stark compliance concepts, cont’d:• Volume or value of referrals:

- Referral is defined as a request by a physician for, or ordering of, or the certifying or recertifying of the need for, any designated health service for which payment may be made under Medicare Part B, including a request for a consultation with another physician and any test or procedure ordered by or to be performed by (or under the supervision of) that other physician, but not including any designated health service personally performed or provided by the referring physician. [42 CFR §411.351]

- CMS favorably considers percentage-based formulas for personally performed services

Key Stark compliance concepts, cont’d:• Commercial Reasonableness:

- The bona fide employment relationship exception, the fair market value compensation exception, and the indirect compensation arrangement exception all require that the arrangement be “commercially reasonable.” The personal services arrangement exception requires that the services be “reasonable and necessary for legitimate business purposes of the arrangement.” [42 C.F.R. §§ 411.357(c)(3), (d)(1)(iii),(l)(4) and (p)(2)]

- The Stark regulations explain commercial reasonableness as: “An arrangement will be considered commercially reasonable, in the absence of referrals, if the arrangement would make commercial sense if entered into by a reasonable entity of similar type and size and a reasonable physician of similar scope and specialty, even if there were no potential designated health services referrals.” [69 Fed. Reg. 16093 (March 26, 2004)]

Federal False Claims Act: [31 U.S.C. §3729]• Any person who knowingly presents, or causes to be presented,

a false or fraudulent claim for payment or approval; knowingly makes, uses, or causes to be made or used, a false record or statement material to a false or fraudulent claim; conspires to commit a violation

• Liability to the United States Government is a civil penalty of not less than $5,000 and not more than $10,000, plus 3 times the amount of damages, which the Government sustains because of the act of that person [31 U.S.C. §3729(a)(7)]

• “Bootstrapped” by prosecutors to AKS and Stark claims

Civil Monetary Penalties Law (“CMPL”): [42 U.S.C. § 1320a-7a]• Many types of CMPLs are set forth in the Social Security Act,

including CMPLs related to the following:- Improperly filed claims- Payments to induce reduction or limitation of services- Authorization by Attorney General

Emergency Medical Treatment and Active Labor Act (“EMTALA”)[42 U.S.C. §1395dd]:• Patients needing emergency care must be given a screening

examination.• The ER must treat the patient until the patient is stabilized. • If the hospital cannot treat the patient, it must transfer the

patient to a facility that can.• Impact on ER staffing and on-call arrangements

- Hospital must maintain list of physicians who are on-call to provide stabilizing treatment for patients with emergency medical conditions

- Statute and regs are silent as to which medical specialties must be represented by on-call physicians

- Lack of guidance for hospitals to use in resolving the issue of physician emergency on-call coverage

Tax Issues• Federally tax-exempt organizations:

- Tax-exempt organizations under I.R.C. § 501 (c)(3) that contract with physicians for services, must ensure that those arrangements do not result in private inurement or convey more than an insubstantial private benefit to avoid jeopardizing tax-exempt status or risking an excise tax due to an excess benefit transaction.

Tax Issues, cont’d:• Excess benefit transactions:

- Section 4958 imposes excise taxes on “disqualified persons” and “organization managers” in connection with “excess benefit transactions” between organizations exempt under Section 501(c)(3) and “disqualified” persons.

- A disqualified person is a person with substantial influence over an organization.

- If a physician is determined to be a disqualified person, compensation paid must equal the value of services provided.

- The value of services is “the amount that would ordinarily be paid for like services by like enterprises (whether taxable or tax-exempt) under like circumstances.”

- The regulations also note that a cap on compensation is a relevant factor in determining the reasonableness of compensation.

Tax Issues, cont’d:• Private inurement:

- An exempt organization must be operated exclusively for charitable purposes, and no part of the organization’s net earnings may inure to the benefit of any private shareholder or individual.

- Any amount of inurement may result in the Internal Revenue Service’s (“IRS”) revocation of an organization’s tax-exempt status.

• Rebuttable presumption of reasonableness:- Treasury regulations provide for straightforward procedures

for insuring compliance with IRC Section 4958 intermediate sanctions rules on reasonable compensation.

Healthcare reform laws:• Fraud and Abuse Revisions:

- Whole Hospital/Rural Provider Exception Revisions [PPACA §6001]

- Stark Self-Referral Disclosure Protocol [PPACA § 6409]- Anti-Kickback Statute – Enhanced Medicare and Medicaid

Program Integrity Provisions [PPACA § 6402]• New Healthcare Delivery Models and Demonstration/Pilot

Programs- Accountable Care Organizations- Impact of quality-related payment and delivery system

reforms

State Laws• Certificate of Need Laws (“CON”):

- CON laws limit expansion of healthcare facilities and to serve as barrier to market competition.

- Some state laws provide exemptions for relocations, capital expenditures subject to threshold, change of ownership, and acquisitions.

- Because of restrictions on establishing certain types of healthcare facilities or offering of certain types of healthcare services, CON laws may have significant value. [See 50 State Survey of Certificate of Need and Licensure: Nursing Homes, Assisted Living, Home Health, and Hospice, American Health Lawyers Association (2009)]

State Laws, cont’d:• State Anti-Kickback laws:

- Applicability to state Medicaid services- Limitations of violations, duty to report, specific behavior- Availability of safe harbor protection

• State Stark Laws:- Applicable to specific payer or unlimited by payer type- Applicable to broad “practitioner”

• State corporate practice of medicine laws• State non-profit and charity laws

Terminology and Definitions

Accountable Care Organization (ACO)• The goal of an ACO should be to reduce, or at least control the

growth of, healthcare costs while maintaining or improving the quality of care patients receive.

• ACOs need to have at least eight components:- Complete and timely information about patients and the

services they are receiving- Technology and skills for population management and

coordination of care- Adequate resources for patient education and self-

management support- A culture of team work among the staff of the practice- Coordinated relationships with specialists and other

providers

Accountable Care Organization (ACO), cont’d• ACOs need to have at least eight components: cont’d

- Coordinated relationships with specialists and other providers

- The ability to measure and report on the quality of care- Infrastructure and skills for management of financial risk- A commitment by the organization’s leadership to improving

value as a top priority, and a system of operational accountability to drive improved performance

Ambulatory Surgery Center (ASC)• A freestanding entity that is specifically licensed to provide

surgery services performed on a same-day outpatient basis.• A freestanding ambulatory surgery center does not employ

physicians.

Ancillary Services• Refer to healthcare services provided exclusive of room and

board• Three categories

- Diagnostic- Therapeutic- Custodial

• Examples include:- Supplies and laboratory tests provided under home care,

audiology, durable medical equipment (DME), ambulatory surgical centers (ASC), home infusion, hospice care, skilled nursing facility (SNF), cardiac testing, mobile lithotripsy, fitness center, and radiology

Anti-kickback Statute• Federal statute

- Section 1128B of the Social Security Act is an intent-based statute that prohibits the knowing and willful offering, paying, soliciting or receiving of any remuneration to induce or to reward referrals of items or services payable by federal healthcare programs, including Medicare and Medicaid. [42 U.S.C. § 1320a-7b(b)]

Capitation• A provider-reimbursement mechanism where a provider

organization receives a fixed, previously negotiated periodic payment per member covered by the health plan in exchange for delivering specified healthcare services to the members for a specified length of time regardless of how many or how few services are actually required or rendered.

• Per member per month (PMPM) is the commonplace calculation unit for such capitation payments.

Centers for Medicare & Medicaid Services (CMS)• CMS is an agency within the US Department of Health & Human

Services responsible for administration of several key federal healthcare programs, which include the following:- Medicare- Medicaid- Children’s Health Insurance Program (CHIP)- Health Insurance Portability and Accountability Act (HIPAA)- Clinical Laboratory Improvement Amendments (CLIA)

• CMS has also been charged with several key tasks for advancing health IT, including implementation of electronic health record incentive programs.

Certificate of Need (CON)• Originated to regulate the number of beds in hospitals and

nursing homes, and to prevent overbuying of expensive medical equipment.

• Mandatory regulation through health planning agencies determined the most urgent healthcare needs, contributed to solutions for these needs, and attempted to manage the fluctuations in prices often caused by a competitive market.

• The idea was that new or improved facilities or equipment would be approved based only on a genuine need in a community.

Collections Ratio• The total amount of collections divided by the total amount of

charges posted by the practice.

Contractual Adjustments• Difference between charges and amounts received or due from

third party payers under contractual agreements.

Conversion Factor• A numerical figure, determined by the Health Care Financing

Administration, which is multiplied by the total RVU for a service to determine its reimbursement amount

Current Procedural Terminology (CPT)• Uniform numbers assigned to every task and service a medical

practitioner may provide to a patient including medical, surgical, and diagnostic services.

• CPT codes are used by insurers to determine the amount of reimbursement that a practitioner will receive by an insurer.

• CPT codes are developed, maintained, and copyrighted by the American Medical Association.

Designated Health Services• Clinical laboratory services• Physical therapy services• Occupational therapy services• Radiology• Radiation therapy services and supplies• DME and supplies• Parenteral and enteral nutrients, equipment and supplies• Prosthetics, orthotics and prosthetic devices• Home health services and supplies• Outpatient prescription drugs• Inpatient and outpatient hospital services

Encounter• A documented, face-to-face contact between a patient and a

provider who exercises independent judgment in providing services to the patient

Evaluation & Management (E&M)• Includes a set of CPT codes ranging from 99201 to 99499• Involves physician-patient encounters in either an office setting

or hospital setting

Fee-for-Service• Fee-for-service equivalent gross charges at the practice’s

established undiscounted rates for all services provided to patients under a commercial contract, or under a Medicare/TEFRA, Medicaid, or similar state healthcare contract

Healthcare Common Procedure Coding System (HCPCS)• HCPCS Level II coding system is a comprehensive,

standardized system that classifies similar products that are medical in nature into categories for the purpose of efficient claims processing.

• Used by Medicare and monitored by CMS

Managed Care• A system in which the provider of care is incentivized to

establish mechanisms to contain costs, control utilization, and deliver services in the most appropriate settings.

• 3 Key Factors:- Controlling the utilization of medical services- Shifting financial risk to the provider- Reducing the use of resources in rendering treatments to

patients• 3 Types of Managed Care Plans:

- Health Maintenance Organizations - Preferred Provider Organizations- Point of Service

Medical Group Management Association (MGMA)• The MGMA survey reports national and regional physician

compensation and productivity data for 2,846 group practices, primarily single specialty practices, representing 59,375 physicians and non-physician providers.

Medicare Part B• Helps cover medically-necessary services like doctors’ services,

outpatient care, home health services, and other medical services to people who are age 65 or older

• Also covers some preventative services

Medicare Physician Fee Schedule (MPFS)• Physician Fee Schedule utilized by Medicare Part B, which lists

more than 7,400 unique covered services and their payment rates

• Covered services include office visits, surgical procedures, anesthesia services, and a range of other diagnostic and therapeutic services

Modifier• Provides the means to report or indicate that a service or

procedure has been performed and has been altered by some specific circumstance but not changed in its definition or code

• Enables health care professionals to effectively respond to payment policy requirements established by other entities

Payer Mix• Refers to the entities other than the patient that finance or

reimburse the cost of health services.• In most cases, this term refers to insurance carriers, other third-

party payers, or health plan sponsors.

Per-click • Unit-of-service (per-click) payments in space and equipment

leases• Prohibits payments to physician-lessor for DHS referred to

lessee by physician• CMS is soliciting comments on prohibitions related to

arrangements involving DHS entities and physician-lessees

Preferred Provider Organizations (PPO)• A healthcare delivery system where providers contract with the

PPO at various reimbursement levels in return for patient steerage into their practices and/or timely payment

• PPOs differ from other healthcare delivery systems in the way they are financed, including providing more choice, benefit flexibility, and enrollee access to providers and medical services both in and out-of-network.

Primary Care• Primary Care specialties include the following:

- Family Practice: General- Family Practice: Sports medicine- Family Practice: Urgent care- Family Practice: with Obstetrics- Family Practice: without Obstetrics- Geriatrics- Internal Medicine: General- Internal Medicine: Urgent care- Pediatrics: Adolescent medicine- Pediatrics: General- Pediatrics: Sports medicine

Procedural Coding• A mechanism for identifying and defining physicians’ and

hospitals’ services• Coding provides universal definitions and recognition of

diagnoses, procedures, and levels of care.

Reimbursement• The healthcare term that refers to the compensation or

repayment for healthcare services.• Reimbursement is being repaid or compensated for expenses

already incurred or, as in the case of healthcare, for services that have already been provided.

• Reimbursement of claims for healthcare services depends on the assignment of CPT codes.

Relative Value Unit• The standardized method of analyzing resources involved in the

provision of services or procedures• Nonmonetary, relative units of measure that indicate the value of

healthcare services and the relative difference in resources consumed when providing different procedures and services

• Relative value units (RVUs) capture 3 components of patient care:- Physician Work RVU – the relative level of time, skill,

training, and intensity to provide a given service- Practice Expense RVU – addresses the costs of maintaining

a practice including rent, equipment, supplies and non-physician staff costs

- Malpractice RVU – generally the smallest component of the RVU values and represents payment for the professional liability expenses

Resource Based Relative Value Scale (RBRVS)• RBRVS is utilized to ensure fair and accurate valuation for all

physician services.• The American Medical Association established a committee to

make annual recommendation regarding new and revised physician services to CMS and performs broad reviews of the RBRVS every five years.

Stark Law• The federal physician self-referral prohibition (“Stark Law”)

prohibits a physician from referring Medicare patients for designated health services (“DHS”) to an entity with which the physician, or the physician’s immediate family member, has a financial relationship, unless the relationship meets the specific requirements of a Stark exception. [42 U.S.C. § 1395nn]

Sustainable Growth Rate• A component of the formula CMS uses to calculate physician

payments for providing services to Medicare patients

Uncompensated Care• Healthcare services by providers that don't get reimbursed,

usually because people don't have insurance and cannot afford to pay for the cost of care

Types of Healthcare Transactions Being Valued

Valuation Opportunities

FMV Business Organization Acquisitions• Hospital acquisitions of medical practices

FMV in Joint Venture Transactions• Hospital and Physician• Physician to Physician• Hospital to Hospital

FMV Related to Facilities Lease Arrangements

Valuation Opportunities, cont’d

FMV compensation involving Equipment Rental Arrangements

FMV compensation in Personnel Employment Leasing Arrangements

FMV compensation Medical Directorships

FMV On-Call Compensation

FMV and Hospital Physician Recruitment Programs

FMV hospital/physician co-management arrangements

FMV physician practice buy-in

FMV physician practice buy-out

FMV physician practice in divorce litigation• Personal v. Enterprise Goodwill

FMV practice mergers

Tax valuations- Gifts- Family limited partnerships- Transfers

Litigation/Dispute Matters

Introduction of Case Study

Large orthopaedic practice located in a highly competitive metropolitan market• Approximately 20 physicians across several sub-specialties • Multi-locations in close proximity to several hospitals• Significant ancillary services including physical therapy

DME, imaging, and an ASC

Ancillary services = approximately 50% of revenue• Significant impact on pre-acquisition physician

compensation

Hospital is negotiating to acquire the practice and employ the physicians

Hypothetical Case Study Scenario

Hypothetical Case Study, cont’d

Hospital utilized two outside appraisal firms • One to value the business • Another to evaluate the fair market value compensation for the

physicians’ post-transaction employment arrangements

Proposed transaction terms:• $20M upfront cash for the business• 25% increase in the physicians’ post-transaction compensation

Significant pressure to get the transaction closed• Including from the Hospital’s CEO

Hypothetical Case Study, cont’d

Business appraiser bifurcated the practice and valued the professional and ancillary service lines separately• Ancillary service lines valued based on discounted cash flow

method• Remainder (professional component) valued based on net asset

value method• The two value indications were then summed to determine the

$20M purchase price

Bifurcated approach resulted in a higher value because no physician compensation expense in the ancillary cash flows

Hypothetical Case Study

Hospital’s general council requests an independent commercial reasonableness assessment and opinion before signing off on the deal.

Questions• Is it commercially reasonable for the hospital to pay $20M

upfront for the practice utilizing a bifurcated valuation approach for the ancillaries--especially when the non-bifurcated cash flows would have produced a much smaller value?

• Is it commercially reasonable for the physicians’ post-transaction compensation to increase by 25% when their historical compensation was significantly impacted from the ancillary services they anticipate selling to the hospital for $20M?

Healthcare Business Valuation Approaches and Methodology

Valuation Approaches

There are three general approaches for valuing any business/asset, which are:• Asset (“cost”) Approach• Income Approach• Market Approach

Asset Approach

Derives an indication of value based on the anticipated cost to replace, replicate, or recreate the asset

Generally used for non-operating-type entities and/or businesses that generate no/nominal cash flow

Net Asset Value Method

Net Asset Value (“NAV”) Method

Provides an indication of value based on the entity’s underlying assets and liabilities

Assets and liabilities are adjusted to their respective current values, and then the liabilities are subtracted Result = the entity’s net equity (i.e. “net asset”) value

Often requires third party appraisals of the tangible assets

Commonly used for businesses that lack positive cash flow (e.g. physician practices with no excess cash flow after subtracting the physicians’ fair market value compensation

Income Approach

Derives an indication of value based on the entity’s earning power (i.e. ability to generate income/cash flow for the owners).

Generally most applicable for operating entities with positive earnings and growth prospects.

Primary methods include:• Discounted Cash Flow Method• Capitalized Income Method

Discounted Cash Flow (“DCF”) Method

Provides an indication of value based on the entity’s ability to generate positive net cash flow• Net cash flow = the excess above all necessary operating costs,

working capital requirements, and capital expenditures• Amount available for distribution to the owner(s)

Cash flows must be projected for a discrete period of time and then discounted to present value utilizing a risk-adjusted discount rate

Terminal period cash flows are capitalized.

Capitalized Income Method

Uses a single period measure of net cash flow as a proxy for future periods

Value determined by capitalizing the single-period cash flow stream with a capitalization rate• Capitalization rate = Discount rate – long term growth rate• Assumes future cash flows will grow at the long-term growth

Primarily used for mature/low growth businesses

Often difficult to use for healthcare entities• The past is not always a reliable indication of the future!

Market Approach

Derives an indication of value based on market transaction data involving similar businesses

Often difficult to use for small/medium-sized healthcare entities due to substantial differences across markets and other factors

Primary methods include:• Guideline Public Company (“GPC”) Method• Merger and Acquisition Transaction (“M&A”) Method

Guideline Public Company Method

Utilizes valuation multiples developed from guideline publicly traded companies

Guideline companies must be “sufficiently similar” to the subject entity but not necessarily the same.

Common multiples include: price/earnings (P/E), price/sales, price/beds, price/book value, etc.

Generally difficult to use for most small/medium- sized businesses

Merger & Acquisition Transaction Method

Provides an indication of value by utilizing valuation multiples developed from similar entities that have been bought/sold

Requires reliable transaction data involving similar businesses

Valuation multiples must be closely correlated to the transaction price.

Irving Levin & Associates – good resource for healthcare transaction data

Valuation Adjustments

Valuation adjustments are sometimes necessary to “adjust” the preliminary value indication to fit the particular facts and circumstances.

Common examples include:• Control premiums• Discounts for lack of control • Discounts for lack of marketability/liquidity • Adjustments for tax benefits associated with certain pass-

through entities

Control Premiums

Control premiums are positive adjustments to the preliminary value indication.

Generally applicable when minority-level cash flows are used to value a controlling interest

Increases the otherwise minority level indication of value to a control level of value

Discounts for Lack of Control (“DLOC”)

Controlling ownership interests are generally worth more, on a per-share/unit basis, than minority interests in the same business.

Empirical “control premium” studies are often used to develop benchmark DLOC adjustments (the inverse of a premium = discount).

Must consider the actual facts and circumstances • Why would an investor likely pay a premium for control of the

subject entity?• Governing documents and rights of ownership

Discounts for Lack of Marketability

Everything else being equal, investments that can be easily and quickly converted into cash are worth more than investments that are illiquid.

Discounts for lack of marketability/liquidity are used to adjust the value indication to a “cash equivalent” basis.

Very facts-and-circumstances driven

Methodologies often controversial

Pass-Through Tax-Benefit Adjustments

When valuing pass-through entities such as LLCs, S-corporations, and partnerships, adjustments may be necessary to account for the more favorable tax benefits associated with the ability to receive non-taxable distributions as compared to taxable dividends from C-corporations.

In theory – a hypothetical buyer would be willing to pay more for an interest if the distributions were non-taxable as compared to taxable.

Generally only applies to minority interests in pass-through entities

Valuation Reports

Types of Valuation Reports

There are several ways in which appraisers can communicate their findings/conclusions including:• Formal (i.e. full scope) reports• Summary/restricted use reports• Oral reports

The deliverable (i.e. how the appraiser communicates his/her conclusions) should be based on the particular facts and circumstances of the engagement and needs of the client.

Types of Reports, cont’d

Formal reports are very detailed (i.e. long) and generally take a lot of time to prepare.

Restricted Use/Summary reports are summarized versions of formal reports.• These reports generally do not include the same level of detail

that would normally be in a formal report.

Oral reports are just oral communications of the appraiser’s analysis and conclusions.• Generally supplemented with supporting schedules

In General - What Should Be Included in Written Valuation Reports?

Client should be clearly identified

Intended purpose of the valuation should be clearly explained

“As of” date should be identified

Standard of value should be stated and defined

Scope of services• Full appraisal • Calculation of value

What Should Be Included in Written Valuation Reports?

Overview of the business

Financial and operational analysis

Industry and economic factors/analysis

Valuation methodologies utilized and why including discussion of key assumptions

Reconciliation of the various value indications and conclusion

Certification

Assumptions and Limiting Conditions

What Should Not Be In The Report

Excessive boilerplate • Unnecessary language that does not add value to the analysis

or conclusion• For example, ten pages of meaningless national economic

statistics as compared to only two pages of financial and operational analysis regarding the subject business

Inappropriate and/or unnecessary analysis, such as: • Inaccurate benchmark comparisons (e.g. cardiology practices to

family medicine, or large hospitals to critical access facilities) • Meaningless ratios (e.g. debt to equity or inventory turnover

ratios for a small physician practice)

Valuation of Healthcare Compensation Arrangements

Valuation of physician compensation arrangements• Broad valuation approaches• Valuation methodology applicable to each approach• Applicability to types of compensation arrangements• Synthesis and reconciliation of methods• Compensation-specific issues in healthcare

- Stacked arrangements- Result of arms-length negotiations between parties in a

position to refer healthcare beneficiaries does not create a market or FMV

Methodology applicable to cost-based approach• Build-up methodology

- Build-up of components of value- Individual components may be valued under cost, income,

and/or market approaches• Avoided cost methodology

- Cost-to-replace- Cost-to-recreate

- In other words, a make-or-buy analysis• Prior rejected offers• Opportunity cost restrictions

Methodology applicable to income-based approach• Professional fee income methods

- Applicable to certain personal service arrangements- Limited to personally performed services

• Technical fee income methods- Bears potential Stark risk, depending on the nature of the

analysis- Applicable in limited circumstances

• Other income methods- Lease arrangements- Other arrangements may include income sources as proxy

for value- Payer quality bonuses

Methodology applicable to market-based approach• Survey methods

- Published survey methods- Ad hoc survey method- Adaptations of survey methods for specific uses

- Conversion of annual survey results to hourly rates- Decisions on levels of survey data

Methodology applicable to market-based approach, cont’d• Scoring, algorithms or judgmental methods

- Factors applicable to physician responsibilities or duties, including complexity and organizational implications

- Skill, experience, credentials, leadership and training- Demand, unmet need and supply issues in the physician

specialty- Productivity and/or profitability- In on-call arrangements, degree of patient acuity; rotation,

frequency and intensity of call; restrictions on physician

Methodology applicable to market-based approach, cont’d• Production-based methods

- Measures of productivity- Published survey metrics

- Collections, net of TC and PE - Encounters- Work RVUs- Ratio metrics- Other metrics

- Interpolation of market data or matching techniques- Application to multiple surveys- Synthesis of results across surveys and production metrics

Methodology applicable to market-based approach, cont’d• Guideline contracts method

- Healthcare contracts- Same specialty or type of arrangement- Different arrangements inside the healthcare industry

- Contracts outside the healthcare industry• May represent only part of the equation, built up with others to

arrive at aggregate FMV for the entire arrangement

Methodology applicable to market-based approach, cont’d• Weaknesses of market data

- Lack of understanding or misinterpretation- Misapplication

- Errors in data gathering and reporting- Data not compatible (i.e., inclusion/exclusion of mid-level

providers, technical component services, modifiers)- Misunderstanding of statistical data (i.e., use of upper

quartile/decile compensation-to-production ratios)- Automatic tendency to gross up for inflation when

inappropriate

Methodology applicable to market-based approach, cont’d

- Data tainted by referral relationships- Small respondent sample sizes- Variations in data

- Geographic- Urban, rural- Payer

- Outdated information- Cherry-picking- Survey respondent error

Methodology applicable to market-based approach, cont’d• Mitigating factors

- Use of multiple surveys or market sources- Weighting to account for weaknesses in market method

results- Use of multiple, market-based methods- Use of other approaches in addition to market-based

approach

Methodology applicable to market-based approach, cont’d• Other common errors

- Failure to recognize differences between W-2 earnings and independent contractor payments and miscalculation of gross-up payroll taxes, benefits and other costs (e.g., malpractice premiums)

- Assumption of equality between administrative and clinical compensation values

Commercial Reasonableness: What is it and How to Assess it?

Commercial ReasonablenessDepartment of Health and Human Services Definition1

• An arrangement which appears to be “a sensible, prudent business agreement, from the perspective of the particular parties involved, even in the absence of any potential referrals”

Stark Definition2

• “An arrangement will be considered ‘commercially reasonable’ in the absence of referrals if the arrangement would make commercial sense if entered into by a reasonable entity of similar type and size and a reasonable physician of similar scope and specialty, even if there were no potential designated health services (“DHS”) referrals.”

OIG Threshold • Compensation arrangements with physicians should be “reasonable

and necessary.”

Several AKS harbors include references to commercial reasonableness:• Space rental• Equipment rental• Personal services and management contracts• Sale of practices

Several Stark exceptions require commercial reasonableness• Office space rental• Equipment rental• Bona fide employment• Group practice arrangements with hospitals• Personal service arrangements

Disparity between FMV and commercial reasonableness:• A transaction can be neither FMV nor commercially reasonable • A transaction can be FMV but not commercially reasonable• An otherwise reasonable transaction can be caused to fail the

commercial reasonableness standard by excessive remuneration

Parties to commercial reasonableness• Legal Counsel – Legal counsel ensures services provided under

an arrangement do not overlap with existing agreements and are structured properly with respect to regulatory standards, as well as ensure agreed-upon compensation is within the range of fair market value of a valuation opinion or internal documentation.

Parties to commercial reasonableness, cont’d• Client – Ideally, the organization proposing an arrangement

should conduct a thorough investigation of commercial reasonableness before legal counsel is involved. As a key role, the organization should base its opinion of commercial reasonableness on the opinion of personnel most acquainted with the operational needs, financial alternatives, and clinical requirements of the underlying arrangement.

• Valuator – A valuator’s primary role in assessing commercial reasonableness is to determine fair market value compensation under the stated arrangement. Additionally, experienced valuators may be able to provide helpful insight of industry and market practices to assist in an opinion of commercial reasonableness.

Key Factors in Evaluating CR

Sample questions for determining commercial reasonableness• Is the proposed arrangement for services reasonably necessary

for the organization’s business operation? If so, why?• Does the organization already provide the services proposed

under the arrangement?• Does the arrangement advance the financial and/or strategic

goals of the organization?• Will the proposed arrangement advance patient care, patient

satisfaction, and overall community benefit?• Is the proposed compensation under the arrangement

consistent with fair market value? • Can a financial return be expected for services performed under

the arrangement absent of referrals from the physician party to the arrangement? If so, what? If not, why?

Questions

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