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Hospital Affiliation Models That Preserve Private Practice

Presented by:Michael L. Blau, Esq. Kelley D. Simpson, Senior PartnerFoley & Lardner LLP Oncology Solutionsmblau@foley.com ksimpson@oncologysolutions.com617-342-4040 404-836-2000

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Fact Pattern• Southwick Hospital– Non-for-profit– 300 bed hospital in community of 350,000– Qualifies for 340B– Plans to build cancer center; Contemplating building

medical oncology and supportive care adjacent to existing radiation oncology facility

• Allied Oncology Associates, P.C.– 7 physician MO group; 5 owners– Offices in Southwick, Wattstown, Hinchendon and

Rottingham• Infusion• Lab• Pharmacy• Retail pharmacy• Non-chemo infusion business which competes with Hospital

infusion service

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Fact Pattern

• Suburban Radiation Associates, P.C.– 3 physician FTE RO group• Treats approximately 800 patients annually• Owns its own facility (10,000 sq. ft.)• Equipment: Three linear accelerators and supporting

equipment

– Hospital currently contracts with a solo RO who is retiring

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Current Oncology Service Financials

• Southwick Hospital• Allied Oncology Associates• Suburban Radiology Associates

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Southwick HospitalOncology Service Line “Virtual Budget”

MEDICAL ONCOLOGY AMISSIONS $ 4,200,000

SURGICAL ONCOLOGY ADMISSIONS 9,400,000

RADIATION ONCOLOGY 3,750,000

MEDICAL ONCOLOGY CLINIC 1,110,000

ONCOLOGY RELATED OUTPATIENTS & ANCILLARIES 14,600,000

ESTIMATED NET REVENUE $ 33,060,000

ESTIMATED TOTAL DIRECT COSTS $ 20,250,000

CONTRIBUTION MARGIN $ 12,810,000

CONTRIBUTION PER NEW CANCER CASE (850 Cases) $ 15,071

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Allied Oncology Associates2010 Financial Position

• New Patients: 1,600• Net Collections: $21,000,000• Drug Cost: $14,000,000• Staff Cost: $3,500,000• Last three years, AOA is

experiencing steady declines (5% or so) in income most notably due to Medicare and non-Medicare rate declines and increased management of drug cost

Net CollectionsLess Practice Expenses: Drugs & Med Supplies Staff Salaries & Benefits Rent EMR: Computer Software & Reporting General & Administrative

$22,150,000

$14,000,0003,500,000

250,00090,000

850,000

Income Before Physicians’ Salaries $3,460,000

Less: Physicians’ Salaries Pension

3,160,00050,000

Net IncomeAdd: Retained Earnings, BeginningLess: Distribution to Shareholders

$250,00025,000

(225,000)

Retained Earnings, Ending -0-

Income Per Physician with Pension $526,429

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Suburban Radiology Associates2010 Financial Position

• New Patients: 850• Net Collections: $9,000,000• Staff Cost: $2,270,000• Space & Equipment:

$3,957,000• With SH committed to build

its own cancer center, SRO is considering what options are available, recognizing a new era of competition.

• SRA’s existing facility is state-of-the-art with room for expansion to include other cancer center program components

Net CollectionsLess Practice Expenses: Staff Salaries & Benefits Medical Supplies & Drugs Equipment Resources & Maintenance Facility Depreciation & Amortization General & Administrative

$9,000,000

$2,270,000100,750

2,620,0001,337,000

500,000

Total Expenses $6,827,750

Net Income/(Loss) $2,172,250

Income Per Physician $724,083

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How to Structure the Transaction?

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Trends in Hospital-Physician Collaboration

• Employment• Practice acquisitions and charitable

contributions• Community oncologists moving on-campus or

into hospital-affiliated groups• Integration and alignment for quality and

efficiency improvement and for multi-disciplinary care

• Legal developments narrow somewhat options for collaboration

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CurrentlyEmploy

No Plan to

Employ

Plan to Employ in Next 2-3

Years

Hospital Employment of Oncologists

n = 126

Hospital Employment of Oncologists

The Advisory Board Company, 2009 Oncology Roundtable

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Percentage of Hospitals Having Implemented or Considering Alignment Models1

n = 107

Continued Interest in Collaborative Arrangements

The Advisory Board Company, 2009 Oncology Roundtable

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CommunityCancer Center

AlliedOncologyAssociates

SouthwickHospital

Payors

Hospital provides:• License• Provider-based status•Space/equipment• Non-physician clinicians (off-campus)

Oncology Groups provide:• Physician staffing•Non-physician clinicians (on campus)• Non-clinical staff• Medical directorship• Management services

Notes:• Medical directorship services provided on fixed fee basis• Physician staffing and management services provided on - Budget-based guarantee - Fee for service - Cost plus or - Fixed fee basis• Must be fair market value (independent appraisal)• Financial terms can be adjusted annually or periodically within decision-making/deadlock resolution framework

ProFees

• Site of servicedifferential

Lease andServices Agreement

$

Medical Director

and Physician

Staffing

$

Hospital

Facility

Fees

SuburbanRadiationAssociates$

Model 1: Hospital (Modified) Under Arrangement Model

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Payors

AlliedOncologyAssociates

SouthwickHospital

ProFees

Lease andServices Agreement

$

Medical Director

and Physician Staffing

$

Hospital

Facility Fees

PrivatePracticeSpace

CommunityCancer Center(Hospital)

Notes:• Same as Model 1, except: - Groups lease private practice space in Cancer Center - Group responsible for practice overhead in private practice space - No site of service differential for private practice services

Model 2: Hybrid (Modified) Under Arrangement Model

SuburbanRadiationTherapy

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SouthwickHospital

Payors

New CancerCenter

(Hospital)

Hospital• License• Provider-based status•Acquires AOA/Suburban equipment/space• Leases AOA/Suburban mid-levels (on-campus)• Employs mid-levels/techs (off-campus)• Leases non-clinical staff

ProfessionalServicesAgreement

$WRVU

$

Staffing/ManagementServices

AOA/Suburban provides:• Physician staffing• Non-clinical staff• Mid-levels/techs to Southwick (on-campus)• Transfer of mid-levels/techs to Southwick (off-campus) • Management services

Model 3: Professional Services Agreement

Off-Campus

Sites

AlliedOncologyAssociatesSuburbanRadiationAssociates

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Key PSA Issues

• Qualification for Medicare provider-based status– Physical space standards for licensure/

accreditation– Can’t lease mid-levels/techs at off-campus sites– Hospital reporting lines– CON issues

• Increased patient co-pays• Payor pushback

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Key PSA Issues• wRVU Valuation

– Relation to existing physician compensation/margins on drugs, labs, pharmacy

– Practice expense component– New physicians/NPs/PAs

• Exclusivity– Existing relationships

• Expansion– Right of first opportunity

• Noncompetes/restrictive covenants• Term/Termination

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Key PSA Issues

• Unwind rights– Asset repurchase– Lease assignment/real estate repurchase– Solicitation of employees– Data/records access/transfer– Systems issues

• Dispute resolution/arbitration– Perform during pendency

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PSA Financial ModelingMedical Oncology Business

BEFORE TRANSACTION: Physician Rates

Payer Class Gross Chgs Collections

Medicare $12,400,000 $8,400,000

Non-Medicare 20,600,000 13,750,000

TOTAL $33,300,000 $22,150,000

AFTER TRANSACTION: Hospital Rates

Payer Class Gross Chgs Collections

Medicare $18,500,000 $7,980,000

Non-Medicare 31,500,000 20,475,000

TOTAL $50,000,000 $28,455,000

Estimated Financial Impact

$6,305,000 +

AOA Drug Cost: $14MMx 20-25% 340B

Drug Pricing Program Discount

$2.8 to 3.5MMDrug Purchasing Savings

TOTALEstimated

Financial Impact$9 to 10MM

TOTALEstimated

Financial Impact$9 to 10MM

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PSA Financial ModelingMedical Oncology: Southwick Hospital

SHBefore

Transaction

SHAfter

Transaction

Net Revenue

Less: Direct Operating Expenses

$33,060,000

$20,250,000

Net RevenueAdd: Incremental Revenue AOA PSA340B Drugs Savings

Less: Direct Operating Expenses Med Onc Incremental Ops Cost AOA PSA Payment Capital Enhancement Costs Addt’l Laboratory Staff Research Program Investment

$33,060,00028,455,000

2,800,000

$20,250,00016,291,000

5,350,650 665,000

48,000148,500

Contribution Revenue $12,810,000 Contribution Revenue $21,561,850

Contribution RevenuePer New Cancer Case $15,017

Contribution RevenuePer New Cancer Case $25,367

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PSA Financial ModelingAllied Oncology Associates

AOABefore

Transaction

AOAAfter

Transaction

Net Collections

Less Practice Expenses: Drugs & Med Supplies Staff Salaries & Benefits Rent EMR: Computer Software & Reporting General & Administrative

$22,150,000

$14,000,0003,500,000

250,00090,000

850,000

PSA: wRVU Payment ($85/wRVU)Billing Services (5% Collections)

Clinical Staff Lease O/H Rate (Cost +3%)Leadership Activities ($150/1,500 Hrs)

Drugs & Medical SuppliesStaff Salaries & Benefits

RentEMR: Software & Maintenance

General & Administrative

$2,724,5051,422,7501,493,500

225,000

$ 0 600,000

50,00090,000

170,000

Income Before Physicians’ Salaries $3,460,000 Income Before Physician Salaries $4,955,755

Less: Physicians’ Salaries Pension

3,160,00050,000

Less: Physicians’ SalariesPension

$4,905,75550,000

Net IncomeAdd: Retained Earnings, BeginningLess: Distribution to Shareholders

$250,00025,000

(225,000)

Net Income Add: Retained Earnings

Less: Distribution to Shareholders

-0--0--0-

Retained Earnings, Ending -0- Retained Earnings, Ending -0-

Income Per Physician with Pension $526,429 Income Per Physician with Pension $707,965

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PSA Financial ModelingRadiation Oncology Business

BEFORE TRANSACTION

Medicare $6,875,000 $2,268,750

Non-Medicare 5,625,000 6,731,250

TOTAL $12,500,000 $9,000,000

AFTER TRANSACTION

Medicare $13,750,000 $1,928,438

Non-Medicare 11,250,000 8,817,938

TOTAL $25,000,000 $10,746,376

Estimated Financial Impact

$1.7MM

• Additionally: Purchase of SRA radiation

oncology business requires valuation of FMV purchase price

Three methodologies typically utilized:

Asset purchase Discounted cash flows Industry multiple of

EBITDA—very generally 3-5x EBITDA

• Assumption is SRA business Assumption is SRA business buyout at 3x EBITDA or $6.5MMbuyout at 3x EBITDA or $6.5MM

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PSA Financial ModelingSuburban Radiology Associates

SRABefore

Transaction

SRAAfter

Transaction

Net Collections

Less Practice Expenses: Staff Salaries & Benefits Medical Supplies & Drugs Equipment Resources & Maintenance Facility Depreciation & Amortization General & Administrative

$9,000,000

$2,270,000100,750

2,620,0001,337,000

500,000

SH Buyout of SRA Rad OncPSA: wRVU Payment ($65/wRVU)

Billing Services (5%) Leadership Activities

Staff Salaries & Benefits Medical Supplies & Drugs

Equipment Resources & Maintenance Facility Depreciation & Amortization

General & Administrative

$6,500,0001,755,000

537,320150,000

$227,000-0-

50,000133,700

50,000

Net Income/(Loss) $2,172,250 One-Time Buyout IncomeIncome Before Physician Salaries

$6,500,0001,981,620

Income Per Physician:Professional & Technical Income $724,083

Buyout Income Per Physician

Income Per Physician:Professional ONLY Income

$2,167,667

$660,540

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PSA Financial ModelingRadiation Oncology: Southwick Hospital

SHBefore

Transaction

SHAfter

Transaction

Net Revenue

Less: Direct Operating Expenses

$33,060,000

$20,250,000

Net RevenueAdd: SRA Incremental Revenue Less: Direct Operating Expenses Rad Onc Incremental Ops Cost SRA PSA Payment Miscellaneous IT & Other

$33,060,00010,746,376

$20,250,0006,367,050 2,442,320

150,000

Contribution Revenue $12,810,000 Contribution RevenueLess: One-Time BuyoutAdjusted Contribution Revenue

$14,597,006(6,500,000)$8,097,006

Contribution RevenuePer New Cancer Case $15,017

Contribution RevenuePer New Cancer Case $9,526

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Southwick HospitalOncology Service Line “Virtual Budget”

MEDICAL ONCOLOGY AMISSIONS $ 4,200,000 $ 4,200,000

SURGICAL ONCOLOGY ADMISSIONS 9,400,000 9,400,000

RADIATION ONCOLOGY 3,750,000 14,496,376

MEDICAL ONCOLOGY CLINIC 1,110,000 32,365,000

ONCOLOGY RELATED OUTPATIENTS & ANCILLARIES 14,600,000 14,600,000

ESTIMATED NET REVENUE $ 33,060,000 $ 75,061,376

ESTIMATED TOTAL DIRECT COSTS $ 20,250,000 $ 49,712,520

SRA BUYOUT -0- 6,500,000

CONTRIBUTION MARGIN $ 12,810,000 $ 18,848,856

CONTRIBUTION PER NEW CANCER CASE (850 Cases) $ 15,071 $ 22,175

ADJUSTED CONTRIBUTION PER CASE(After Radiation Oncology Buyout)

$ 15,071

$ 29,822

SHBefore

Transaction

SHAfter

Transaction

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Model 4: Service Line Co-Management Arrangements

• The purpose of the arrangement is to recognize and appropriately reward participating medical groups/physicians for their efforts in developing, managing, and improving quality and efficiency of the hospital’s service line

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SouthwickHospital

MOService

Line

Hospital-licensedservices

Other Group (s) ?

SuburbanRadiation

Associates

Allied OncologyAssociatesCo-Management

Agreement

• Multi-party contract• Allocates effort and reward between groups

OperatingCommittee

Designees

DesigneesPayors

$

Model 5: Service Line Co-Management Direct Contract Model

ROService

Line

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MOService

LineCo-ManagementAgreement

• Capital Contributions• Management Infrastructure

Payors

$

Service LinePhysicians/

Groups

JVManagement

Company

SouthwickHospital

ProfitDistribution

ProfitDistribution

Service Line Co-Management Joint Venture Model

ROService

Line

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Service Line Co-Management Arrangements

• There are typically two levels of payment to oncologists under the service line contract:– Base fee – a fixed annual base fee that is

consistent with the fair market value of the time and efforts participating oncologists dedicate to the service line development, management, and oversight process

– Bonus fee – a series of pre-determined payment amounts contingent on achievement of specified, mutually agreed, objectively measurable, program development, quality improvement and efficiency goals

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Service Line Co-Management Arrangements

• Pays participating oncologists 3-6% of service line revenues– Fixed, fair market value; independent appraisal

advisable

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Regulatory Considerations• Legal constraints on Service Line Co-

Management Agreements– No stinting– No Steering– No cheery-picking– No gaming– No payment for changes in volume/referrals– No payment for quicker-sicker discharge– Must by FMV; independent appraisal required

• Proposed Stark Law Exception for Incentive Payment and Shared Savings Programs

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Key Service Line Co-Management Issues

• Scope of service line under management– Separate/combined MO/RO service line

• Service line co-management services– No overlap with PSA or Employee Lease– Documentation

• Performance standards and targets– Validation– Achievability– Reset

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Key Service Line Co-Management Issues

• Term/durability– Rev. Proc. 97-13 (3 years)

• Dilutive effect of adding physicians• Independent appraisal of fair market value• Cost of independent monitor, valuation,

security offering (for JV)• Some irreducible legal risk

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Financial Model of Service Line Co-Management Arrangement

MEDICAL ONCOLOGY AMISSIONS $ 4,200,000 $ 4,200,000 $ 4,200,000

SURGICAL ONCOLOGY ADMISSIONS 9,400,000 9,400,000 9,400,000

RADIATION ONCOLOGY 3,750,000 14,496,376 14,496,376

MEDICAL ONCOLOGY CLINIC 1,110,000 32,365,000 32,365,000

ONCOLOGY RELATED OUTPATIENTS & ANCILLARIES 14,600,000 14,600,000 14,600,000

ESTIMATED NET REVENUE $33,060,000 $ 75,061,376 $ 75,061,376

ESTIMATED TOTAL DIRECT COSTSSRA BUYOUTCO-MANAGEMENT SERVICES AGMT (3.5%)

$20,250,000 $ 49,712,5206,500,000

-0-

$ 49,712,5206,500,000

3,002,455

CONTRIBUTION MARGIN $12,814,000 $ 18,848,856 $ 15,846,401

CONTRIBUTION PER NEW CANCER CASE (850 Cases) $15,070 $ 22,175 $ 18,643

ADJUSTED CONTRIBUTION PER CASE(After Radiation Oncology Buyout) $15,070 $ 29,822 $ 26,290

SHAfter PSA

Transaction

SHAfter PSA

& Co-MgmtTransactions

SHBefore

Transactions

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AlliedOncologyAssociates

SouthwickHospital

Payors

Employee Lease Agreement

$

Professional Services

Agreement

$

Notes:• Same as Model 3, plus• Service Line Co-Management Agreement (3-6% of Service Line revenue) - PSA component – WRVU rate equal to aggregate current physician compensation - Employee lease – cost plus - Co-management component – fixed fair market value fee - Incentive component contingent on meeting specified quality and efficiency improvement standards – fixed FMV fee per standard

Service LineCo-ManagementAgreement

New CancerCenter

(Hospital)

PSA with Service Line Co-Management Agreement

SuburbanRadiationAssociates

Off-Campus

Sites

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Financial Model of Combined PSA/Service Line Co-Management Arrangement

Income: $6,269,483Per Doc: $895,640

Incremental Income:• PSA: $ 1,495,755• Clinical productivity• Leadership activities• Billing services• Clinical staff lease

• Co-Mgmt: $1,313,728

MEDICALONCOLOGY

BEFORE

Income: $3,460,000Per Doc: $526,429

AFTER

Buyout: $6,500,000Per Doc: $2,166,667

Income: $1,981,620Per Doc: $1,098,449 + Buyout $$$

Incremental Income:• Business Acquisition• Co-Mgmt: $1,313,728

RADIATIONONCOLOGY

BEFORE

Income: $2,172,250Per Doc: $724,083

AFTER

Contribution: $15,846,401Per Case: $18,643

After Buyout: $22,346,401Per Doc: $26,290

Incremental Income:• Tangible, medical oncology• Tangible, radiation oncology• Intangibles: Efficiencies from co-

mgmt; greater leadership participation; market penetration/lessen outmigration; ancillary services; etc.

SOUTHWICKHOSPITAL

BEFORE

Contribution: $12.8MMPer Case: $15,070

AFTER

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APPENDIX

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Financial Modeling Assumptions

• 7 FTE medical oncologists• Practice mix of 50/50 Medicare

and non-Medicare • Median MGMA wRVUs per doc

of 4,579• Payment of $85 per wRVU • Billing services at 5% of SH net

collections ($28.4MM)• Clinical staff lease for 50% of

staff (on campus) at cost plus 3%• Leadership activities for 1,000

hours annually at $150 per hour• AOA retains non-clinical staff

and related space and equipment cost to provide billing and management services

• 3 FTE radiation oncologists• Practice mix of 55/50 Medicare

and non-Medicare • Median MGMA wRVUs per doc of

9,032• Payment of $65 per wRVU • Billing services at 5% of SH net

collections ($10.7MM)• Radiation oncology facility is

located off-campus; therefore all clinical staff must be directly employed by SH• Leadership activities for 1,000

hours annually at $150 per hour• SRA retains non-clinical staff and

related space and equipment cost to provide billing and management services

• Incremental medical oncology expenses of $22,503,150

–Operations: $16,291,000PSA Payment: $5,350,650Capital Enhancements: $665,000 Addt’l Lab Staff: $48,000Research: $148,500

• Incremental radiation oncology expenses of $6,959,370

–Operations: $6,367,050PSA Payment: $2,442,320Enhancements IT & Other: $150,000 –One-Time Buyout: $6,500,000

• Co-Management Agreement at 4% of overall oncology service line revenues less leadership activities of $375,000. Distribution of co-management fees assumed at a 50/50 split of medical oncology to radiation oncology

Medical Oncology Radiation Oncology Hospital