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Special Issuance of Four Email Alerts


Email Alert

November 30, 2009

The Business Law and Governance Practice Group is pleased to share four of its previously issued email alerts with Healthcare Reform Educational Task Force members. These email alerts were written with the specific purpose of considering the viability of business models for the healthcare delivery system in view of proposed healthcare reform legislation. Please note that these alerts were written in September and October 2009 and reflect the then-status of healthcare reform legislation. Nevertheless, the alerts raise significant issues to be considered in the context of the ongoing legislative process. The four alerts are:

  1. Healthcare Reform Will Challenge Providers' Business Structures
    Kim Roeder, Esquire (King & Spalding LLP, Atlanta, GA)

  2. Rethinking Freestanding Diagnostic Imaging Centers: Prospects for
    Business Affiliations
    Thomas Greeson, Esquire, and Paul Pitts, Esquire (Reed Smith LLP, Falls Church, VA, and San Francisco, CA)

  3. Ambulatory Surgery Centers: Unique Providers in Challenging Times: A Viable Business Model
    Lorin Patterson, Esquire and Cynthia Alcantara, Esquire (Reed Smith LLP, Falls Church, VA)

  4. Physician-Hospital Integration as a Business Model
    Matthew Albers, Esquire (Vorys Sater Seymour and Pease LLP, Cleveland, OH)

September 9, 2009

Business Law Update

Healthcare Reform Will Challenge Providers' Business Structures
By Kim Roeder*

As the debate over healthcare reform continues, the form of any future legislation remains unclear. Certain aspects of the debate, however, have raised questions about the shortcomings of the current fee-for-service healthcare delivery system that will likely persist, whether or not final legislation includes such controversial elements as a public plan option, a federally regulated health insurance exchange, and individual and employer health insurance coverage mandates. Policy positions, advocacy papers, and draft legislation have addressed a variety of proposals designed to spark changes in healthcare delivery, promoting a focus on wellness and primary care, shifting payments from a fee-for-service structure based on volume to methodologies that reward quality, and encouraging coordination of patient care across the provider spectrum through bundled payments structures and payment incentives.

Delivery System Reform

Although the ultimate resolution of the legislative debate is far from clear, a survey of the major outstanding House and Senate proposals indicates that providers would be well advised to begin some consideration of strategic options to position them for a business response to incentives and mandates as discussed in the context of a public plan, private plans operating through an exchange, or proposed Medicare and Medicaid payment adjustments. Various proposals under consideration will impact directly relationships among hospitals, physicians, and post-acute providers:

  • Innovative and Alternative Payment Arrangements. The House reform bill, America's Health Choices Act of 2009, specifically authorizes the public plan option to compensate participating providers under fee structures representing an alternative to traditional fee-for-service payments, including patient-centered medical home and other care-management payments, accountable-care organizations, value-based purchasing, bundling of services, differential payment rates, performance or utilization-based payments, and partial capitation.1

  • Payments Based on Quality. The House bill authorizes a number of initiatives designed to develop quality measures for payment purposes.2 Although the Senate Finance Committee did not release a bill before Labor Day, the committee's April 2009 policy option publication includes various proposals to control healthcare costs by paying hospitals performance bonuses under the inpatient prospective payment system (IPPS) for meeting or improving upon prescribed performance measures focusing on such matters as cardiac conditions, pneumonia, surgical care, and patient evaluations of care. Across-the-board reductions in IPPS payment rates would be implemented to fund these bonuses.3 Only hospitals scoring in the top quartile would receive the full bonus; those in the bottom quartile would receive no bonus, and those in the second and third quartile would receive a partial bonus.

  • Bundled Payments. The House bill directs the U.S. Department of Health and Human Services Secretary to develop a detailed plan to implement post-acute bundled payments, and expands an existing demonstration project to include bundling of payments for hospitals and post-acute providers.4 The Senate Finance Committee's policy options include a proposal under which Medicare would pay a singled bundled payment amount for both inpatient services and certain post-acute services, including home health, skilled nursing facility, rehabilitation, and long-term hospital care, if furnished within thirty days after discharge from the acute-care hospital. The bundled payment rate would reflect savings attributed to the anticipated efficiencies achieved through improvements in the coordination of services.5

  • Hospital Readmissions. The House bill provides for adjustment of hospital payments based on the dollar value of each hospital's percentage of potentially preventable Medicare readmissions for three conditions with risk-adjusted readmission measures that are endorsed by the National Quality Forum. In future years, this policy is to be expanded to additional conditions.6 In addition, risk-adjusted readmission rates would be developed for post-acute providers, and a readmission payment system similar to the hospital system would be implemented for post-acute providers. The potential for reduction in payment due to readmissions may incentivize coordination among acute and post-acute providers.

Business Structures

Hospitals, physicians, and other providers considering a transactional response to this landscape may consider the following continuum of business arrangements:

  • Independent contractor service arrangements between hospitals and physicians and among hospitals, physicians, and post-acute providers. The ability to implement coordination of care and enforce commitment to quality and other incentives may be more challenging—both operationally and legally—in structures in which providers remain independent outside the specific terms of the contract.

  • Employment of physicians by providers . Even in the absence of new healthcare reform legislation, employment of physicians by hospital systems has been increasing due to a number of market pressures, including shortages of physicians; the need to plan for recruitment in certain specialties to replace retiring practitioners; reimbursement pressures that have led to demands for higher payments for call coverage and administrative services; an emphasis on lifestyle choices and less investment in the independent private practice model among young physicians; and the like. Employment may furnish a framework for developing protocols for coordination and implementing quality and patient care coordination incentives.

  • Joint ventures for the co-management of clinical matters in certain service lines (particularly those that will be subject to particular scrutiny and penalties). Many such joint ventures in recent years have centered on hospital-physician joint ventures to manage certain hospital service lines. Health reform may indicate that focus should be directed to efforts promoting clinical management across a broader group of providers, including post-acute providers.

  • Joint ventures for negotiation of payor contracts, such as a physician-hospital organization (PHO) or a physician independent practice association (IPA). Under antitrust rules, organizations of this type have been limited to a complex messenger model involving individual responses to payor pricing unless the organization implemented substantial economic or clinic integration.7

  • Joint ventures for ownership of healthcare facilities. Co-ownership is one method for incentivizing investors in the success of the facility's operations. Joint venture opportunities involving physicians are severely limited under the Stark Law. It should be noted that House and Senate HELP bills would eliminate the Stark Law exception for physician ownership of hospitals.

  • Acquisitions and vertical integration of providers. Although common ownership may be a flexible legal vehicle for aligning incentives and negotiating with payors across a spectrum of providers (including acute and post providers, as well as physicians), acquisition (and subsequent integration) may be expensive, time-consuming, and require compliance with a number of change-of-ownership rules.

While these structures may provide a framework for the administration of global capitation and bundled payments, the successful implementation of clinical integration, patient care coordination, quality incentives, and efficiencies across previously unaffiliated providers will require innovative leadership and management.

Legal Issues

As noted above, implementation of any of the foregoing structures to respond to various reform proposals meets significant challenges under at least the following laws as currently in effect:

  • Referral Laws. Cooperation among providers, including physicians and providers who serve as referral sources to each other, presents basic compliance issues under the Stark Law8 and federal Anti-Kickback Statute9 (and their counterparts at the state level that may be applicable to Medicaid and private insurance programs). Joint venture opportunities involving physicians are limited under the Stark Law and the Anti-Kickback safe harbors; and services contracts must meet highly formalized requirements relating to documentation of the arrangement, setting compensation in advance for at least one year, limiting bonuses to regulatory criteria, and compliance with standards of fair market value payments.10

  • Antitrust Laws . Transactions among healthcare providers that involve sharing of price-related information among healthcare providers and joint ventures for specialty health services, mergers, or establishment of physician and multi-provider networks such as IPAs and PHOs for contracting purposes, are still subject to guidelines published in the 1990s, the Department of Justice and Federal Trade Commission Statements of Antitrust Enforcement Policy in Health Care (Joint Statements). The antitrust laws are actively enforced against providers, IPAs, and PHOs that cannot demonstrate sufficient financial or clinical integration to deal jointly with payors or that otherwise run afoul of antitrust prohibitions.11

  • The CMP Statute and "Gainsharing." The HHS Office of Inspector General (OIG) has long taken the position that arrangements for sharing hospital cost savings with physicians incorporating certain efficiencies in their practice are at least technical violations of the statute imposing a civil monetary penalty for a hospital's payment made to a physician to induce reductions or limitations of services to Medicare or Medicaid beneficiaries under the physician's direct care.12 Under its advisory opinion process, the OIG has approved a number of arrangements that include substantial protective measures surrounding programs such as product standardizations or pay-for-performance, under which a private insurer paid the hospital a bonus based on certain standards of quality and efficiency.13 Reliance on the advisory opinion process to assure compliance is cumbersome and time-consuming for wide-ranging implementation of such measures. The House bill extends the CMS gainsharing demonstration project in order to further study these programs.14

  • Tax-Exempt Status Regulations. The ability of Section 501(c)(3) charitable healthcare providers to engage in business transactions with for-profit business entities is limited by tax guidance and regulations regarding their participation in joint ventures with for-profit partners,15 and the imposition of excise taxes in connection with compensation arrangements and other transactions that are determined to be excess benefit transactions within the meaning of the intermediate sanctions rules.16

Planning a transactional response to healthcare reform efforts will require close attention to whether and how these principles are modified to enable providers to structure business relationships in response to incentives, mandates, and innovative payment mechanisms.

*AHLA wishes to thank Kim H. Roeder, Esquire (King & Spalding LLP, Atlanta, GA), for authoring this alert and sharing her expertise with other colleagues.

1 H.R. 3200, Section 224.
2 H.R. 3200, Sections 1441-1444.
3 "Transforming the Health Care Delivery System: Proposals to Improve Patient Care and Reduce Health Care Costs," Senate Finance Committee, April 29, 2009.
4 H.R. 3200, Section 1152.
5 "Transforming the Health Care Delivery System: Proposals to Improve Patient Care and Reduce Health Care Costs," Senate Finance Committee, April 29, 2009.
6 H.R. 3200, Section 1151.
7 See the Department of Justice and Federal Trade Commission Statements of Antitrust Enforcement Policy in Health Care, available on the FTC website.
8 42 USC § 1395nn.
9 42 USC § 1320a-7b(b).
10 See Stark rules at 42 CFR Part 411, Subpart J; and the Anti-Kickback Law safe harbors at 42 CFR § 952.1001.
11 See actions cited in Overview of FTC Antitrust Actions in Health Care Services and Products, Health Care Division, Bureau of Competition, Federal Trade Commission (June 2009), available on the FTC website.
12 42 USC 1320a-7a(b).
13 OIG Advisory Opinion No. 08-16; OIG Advisory Opinion No. 09-06.
14 H.R. 3200, Section 1903.
15 See Revenue Ruling 98-15.
16 IRC § 501(c)(3); IRC § 4958.

September 22, 2009

Business Law Update

Rethinking Freestanding Diagnostic Imaging Centers Prospects for Business Affiliations
By Thomas Greeson and Paul Pitts*

Over the past decade, diagnostic imaging services have been among the fastest growing medical services paid under the Medicare Physician Fee Schedule (MPFS).1 These services have been targeted for payment reductions and other regulatory restrictions due to this rapid growth. As summarized below, both Congress and the Centers for Medicare & Medicaid Services (CMS) have taken steps to significantly reduce payments for the technical component of diagnostic imaging services paid under the MPFS, including services provided in facilities enrolled in Medicare as physician practices (both radiology and non-radiology) or as independent diagnostic testing facilities (IDTFs).

The declining reimbursement, rising technology costs, and escalating competition have prompted diagnostic imaging facilities around the country to reconsider their choice to enroll in the Medicare program. In particular, many radiology practices and owners and managers of imaging centers have been investigating alternative structures since January 1, 2007, when the Deficit Reduction Act of 2005's payment cuts reduced technical component payments to the lesser of the payment under the MPFS or the Hospital Outpatient Prospective Payment System (HOPPS). The adoption of new regulatory requirements, including, among other things, new performance standards that have been promulgated for IDTFs, have accelerated this trend.2

For 2010, both CMS and Congress are considering steep cuts to reimbursement of the technical component of imaging services. CMS proposes to increase utilization expectations for imaging equipment from 50% to 90%, which would dramatically reduce the per-procedure practice expense formula under the MPFS. CMS also proposed a 50% reduction for multiple procedures on contiguous body parts that are discounted to technical component relative values and Medicare payment rates. Further, CMS proposes to use the new American Medical Association Physician Practice Information survey data, which could result in further cuts regardless of any Congressional action this fall.

Although legislation is moving through the House, many believe that Senate Finance Committee Chair Max Baucus' (D-MT) mark could become the eventual vehicle for healthcare reform.3 The mark attempts to roll out cuts for imaging services in a somewhat more ordered manner. Baucus proposes to increase the utilization rate assumption for calculating the payment for advanced imaging equipment from 50% to 65% for 2010-2013. The rate would be further increased to 75% in 2014. Department of Health and Human Services Secretary (HHS Secretary) Kathleen Sebelius would be required to conduct a study by January 1, 2013, on the utilization rate change's estimated impact, covering the following: (1) beneficiary access, including in rural areas; (2) utilization of advanced diagnostic imaging services; and (3) the estimated savings to the Medicare program over the period of 2010-2019. In addition, Baucus' proposal would increase the technical component payment reduction for multiple imaging services on contiguous body parts during the same visit from 25% to 50%.

Regardless of the outcome of the healthcare reform debate, it appears increasingly likely that freestanding diagnostic imaging centers will experience additional payment cuts in 2010. A number of alternates are available to freestanding centers to decrease their exposure to these cuts, including restructuring as a provider-based facility or the outright sale of assets to the hospital system, both of which allow the hospital to bill under the more favorable HOPPS rates. Any realignment of the relationship between a freestanding imaging center and a hospital requires a close study of the inevitable changes in compensation and control of the imaging center's operations. Each alternative has its own set of challenges and opportunities.

Provider-Based Joint Ventures

A provider-based joint venture is one alternative for freestanding diagnostic imaging centers located on or near the hospital's main campus. "Provider-based" status generally determines the manner in which services provided in a facility that is physically and/or legally distinct from a hospital may be billed to the Medicare program under the hospital's Medicare provider agreement and National Provider Identifier. Unlike freestanding imaging centers, provider-based imaging centers bill a facility charge to Medicare Part B on the UB 92 claim form and, to the extent that the hospital's overhead costs (i.e., billing personnel, medical records system) are shared by the outpatient imaging facility, the hospital may allocate these costs to the outpatient imaging facility. To bill under the hospital's Medicare provider agreement, the Medicare provider-based rules set forth specific requirements that a facility must meet to be deemed "provider-based" and treated as part of the hospital.4

The location requirements of the provider-based rules create a significant limitation on this restructuring alternative. The provider-based rules permit hospitals to provide and bill for services furnished by a joint venture if the facility is located on the hospital's main campus. For purposes of the provider-based rules, a facility will be considered to be located on the hospital's campus if it is located on "the physical area immediately adjacent to the [hospital's] main buildings, other areas and structures that are not strictly contiguous to the main buildings but are located within 250 yards of the main buildings, and any other areas determined on an individual case basis, by the CMS regional office, to be part of the [hospital's] campus."5

In addition to the location requirements, the rules impose significant limits on an outside vendor's management of the facility. While the provider-based rules permit hospitals to contract for management services for provider-based facilities (e.g., with a radiology practice that has the capacity to manage an imaging center), the contractor's role is substantially limited because the provider-based facilities must integrate administrative functions and clinical staff with the hospital. Accordingly, as a provider-based entity, the hospital's administration will have more authority over the imaging center than they might have over a joint venture enrolled in the Medicare program as a physician practice or an IDTF.

Payment rates and control of the operations are not the only factors to consider when restructuring an outpatient imaging facility. The co-pay responsibility for Medicare patients can be substantially higher under HOPPS. Under HOPPS, a greater portion of the allowed payment is shifted to the patient, which can be more difficult and time consuming to collect. Of course, many Medicare patients have supplemental insurance that would address this difference in payment. The percentage of patients with supplemental insurance will vary depending on the local market's economics. In some markets, the competitive disadvantage of higher co-pays can be significant.

Lease and Management Arrangement

In situations where the imaging center is located off the main campus of the hospital, an alternative to a provider-based joint venture is an arrangement where the space and equipment necessary for operating the imaging center are leased to the hospital. In a lease arrangement, the hospital operates the former group practice or IDTF as a provider-based imaging center that bills its services under HOPPS. The on-campus restrictions that apply to provider-based joint ventures do not apply in a lease arrangement where the hospital licenses the space and has exclusive control over the imaging facility. Consequently, off-campus facilities could also meet the provider-based requirements if the facility is within thirty-five miles of the hospital and the hospital retains substantial responsibility and control over the delivery of services at the facility.

As a condition of the lease agreement, the hospital typically enters into a long-term management agreement with the radiology group (or owner of the assets) for the management of the imaging center. A lease and management arrangement limits the control the radiologists or owner of the assets may exert over services offered at off-campus facilities. For off-campus facilities operated under a management agreement, the Medicare provider-based rules require, among other things, that: (1) the hospital must employ the staff of the facility who are directly involved in the delivery of patient care (e.g., all technologists); (2) the billing, records, human resources, payroll, and similar administrative functions must be integrated with those of the hospital and should be handled by the same group of employees that perform those functions for the hospital; and (3) the hospital must have significant control over the operations.6

As a result of these restrictions, the ability for the owner of the imaging center assets to provide a full range of management services, including staffing the facility with technologists, is significantly restricted. The radiologists are limited to providing the facility: (1) front-desk and back-offer personnel; and (2) an administrator and medical director who could provide general management and oversight of administrative and patient care activities to the facilities. While a manager may make recommendations on key issues, the ultimate decision on administrative issues, including personnel actions and approval of contracts, must be made by the hospital.

Sale of Business to Hospital System

Another option for imaging centers is the outright sale of assets to a local hospital system. As a condition of sale, radiology groups enter into a long-term management agreement with the hospital for the management of imaging centers and professional services agreements that allow the radiology practice to continue to provide professional medical services to the hospital's patients. For some radiology groups and owners of freestanding imaging centers, the opportunity to manage an imaging service line with no ownership interest can be an attractive opportunity if the parties are able to reach an agreement that provides the manager with sufficient security, control, and compensation. Recognizing their ability to increase revenues as a provider-based service, hospital administrators are often eager to purchase and operate imaging centers as provider-based facilities.


In the current economic and regulatory environment that confronts freestanding diagnostic imaging centers, the trend toward structuring a new relationship with a local hospital is likely to continue. Due to the complexity of the issues involved, hospitals, radiologists, and other owners and managers of imaging centers often require legal and financial advice to construct an arrangement that meets each party's expectations and, when applicable, meets the requirements of the Medicare provider-based rules.

*We would like to thank Thomas Greeson, Esquire, and Paul Pitts, Esquire (Reed Smith LLP, Falls Church, VA, and San Francisco, CA), for co-authoring this alert and sharing their expertise with other colleagues.

1 See U.S. Gen. Accounting Office, Medicare Part B Imaging Services: Rapid Spending Growth and Shift to Physician Offices Indicate Need for CMS to Consider Additional Management Practices, GAO-08-452, June 13, 2008.
2 See 42 C.F.R. § 410.33(g).
3 See U.S. Senate Committee on Finance, Chairman's Mark, America's Healthy Future Act of 2009, Sept. 16, 2009.
4 See 42 C.F.R. 413.65.
5 Id. § 413.65(a).
6 Id. § 413.65(h).

October 15, 2009

Corporate Governance Update

Ambulatory Surgery Centers: Unique Providers in Challenging Times A Viable Business Model
By Lorin Patterson and Cynthia Alcantara*

Ambulatory surgery centers (ASCs) are distinct entities that operate exclusively for the purpose of providing surgical services to patients not requiring hospitalization and in which the expected duration of services does not exceed twenty-four hours following admission.1 The first ASC opened in 1970. As evidence of the "seismic shift" to the outpatient arena that has occurred over the last decade, by 2008, there were approximately 5,300 ASCs in the United States that performed a total of five million outpatient surgeries.

ASCs present numerous unique issues for healthcare attorneys. For example, physicians directly own many ASCs. Hospitals and management companies frequently also own interests in ASCs alongside physicians. Services performed within ASCs are also generally not "designated health services" under the Stark Law, and that statute's restrictions thus do not apply. Finally, ASCs are also unique in that the federal Anti-Kickback Statute safe harbor that protects investments in ASCs actually requires physicians to utilize the ASCs in which they are investors.2

Prior to 2008, Medicare reimbursed ASCs for certain approved surgical procedures according to a fee schedule comprised of nine classes of payment rates. When Medicare approved reimbursement for services furnished in ASCs in 1982, there were approximately 100 procedures on the list of covered procedures. More procedures are added to the list each year. This reimbursement scheme bore no relation to the manner in which the Centers for Medicare & Medicaid Services (CMS) reimbursed hospitals for performing outpatient procedures.

A revised ASC payment system was implemented beginning in 2008. The revised payment system significantly expanded the scope of surgical procedures covered in ASCs. Under the new system, ASCs may be reimbursed for any surgical procedure that may be safely performed in an ASC and that is not expected to require an overnight stay.3 CMS moved from only paying for services included on a list of procedures approved by CMS to permitting payments for any surgical procedure except for those specifically excluded by CMS.

Under the new system, ASC reimbursement is based on payments for similar procedures provided in hospital outpatient departments (HOPDs) or physician offices. CMS determines ASC payment rates based on the hospital outpatient prospective system (HOPPS) ambulatory payment classifications.4 CMS also now provides payment to ASCs for surgical procedures that are predominantly performed in physicians' offices.5 Payments for such "office-based" procedures are capped at the non-facility practice expense component of the Medicare physician fee schedule payment rate in the physician office setting. Separate payments are permitted for certain covered ancillary services, including radiology services and drugs and biologicals that are integral to the covered surgical procedures.6 The new ASC payment system is being phased in over a four-year period that began in 2008.7

As recently as 2004, Medicare reimbursement for ASC procedures was on average 86% of the payment rates to HOPDs for the same services. As a result of payment freezes and additional cuts, ASCs were receiving 65% of the HOPD rate in early 2009. That percentage has dropped to 59% and will be an estimated 58% in 2010.8 The Ambulatory Surgical Center Access Act of 2009 was introduced earlier this year to address the widening gap between ASC and HOPD payments, with the effect of increasing patient access to high-quality, low-cost services in the ASC setting. As proposed, the Act would fix ASC payment levels at 59% of HOPD rates.9

As a result of the increasing divergence between ASC and hospital payments, in recent years a number of freestanding ASCs have either converted to hospitals or become provider-based outpatient departments of existing hospitals. These efforts are not without risk given: (1) the uncertainty in the future of physician-owned hospitals,10 and (2) the regulatory restrictions applicable to attaining provider-based status.

The most recent proposals to curb physician ownership in hospitals are contained in the various drafts of Congress' healthcare reform bills. For example, draft healthcare reform legislation proposed in the Senate Finance Committee would prohibit a physician from referring Medicare beneficiaries to a hospital in which he or she has an ownership interest.11

The implementation of healthcare reform will likely have significant ramifications for ASCs. The discrepancy between Medicare spending on HOPDs versus ASCs suggests that utilization of ASCs saves the Medicare program money. Since other payors' rates are frequently based on Medicare's reimbursement levels, ASCs will also provide lower-cost alternatives to other payors and their beneficiaries. A recent study by KNG Health Consulting, an independent health economics and policy firm, found that ASCs have played a "pivotal role" in moving services to less expensive but clinically appropriate settings.12 The study shows, as evidence of the movement of surgeries to smaller outpatient settings, that 70% of the growth in ASC services from 2000-2007 results from the movement of procedures from HOPDs to ASCs. Further, the proposed 2010 ASC payment rule includes the addition of twenty-six surgical procedures that will be covered by Medicare in ASCs.

A major reason for healthcare reform is clearly to expand access to health insurance coverage. ASCs should benefit from increased patient volume resulting from an increase in the insured population, because patients with insurance tend to utilize healthcare services to a greater extent than the uninsured. The existence of fewer uninsured patients could also benefit ASCs by reducing the amount of bad debt.

ASCs may also experience increased regulation and oversight under any new reform regime. Requirements for ASCs to participate in quality reporting and to report on costs, quality, and infection control are being proposed in connection with healthcare reform legislation. For example, under a House of Representatives proposal, ASCs would be required to report on healthcare-associated infections to the Centers for Disease Control and Prevention and would be refused Medicaid payments for certain healthcare-associated conditions.13 Increased government oversight and focus on compliance will burden ASCs with more administrative responsibilities and costs.

While ASCs should not expect higher reimbursement rates in the future, they should expect to play an important role in attaining the goals of low costs and high quality in reforming our nation's healthcare system. Those ASCs that prosper will be those that are "nimble" enough to cover the costs associated with increased regulatory burdens with increased revenue from greater patient flow at "challenging" rates.

*AHLA wishes to thank Lorin Patterson, Esquire, and Cynthia Alcantara, Esquire (Reed Smith LLP, Falls Church, VA), for co-authoring this alert and sharing their expertise with other colleagues.

1 42 C.F.R. § 416.2.
2 42 C.F.R. § 1001.952(r).
3 42 C.F.R. § 416.65.
4 42 C.F.R. § 416.166(b).
5 42 C.F.R. § 416.166(a).
6 42 C.F.R. § 416.164(b).
7 42 C.F.R. § 416.171(c).
8 74 Fed. Reg. 35232, July 20, 2009.
9 See Ambulatory Surgical Center Access Act of 2009, H.R. 2049, Apr. 22, 2009.
10 There are currently more than 220 physician-owned hospitals in the United States. A number of attempts have been made over the past few years to pass legislation that would prohibit or restrict physician-owned hospitals.
11 See U.S. Senate Committee on Finance, America's Healthy Future Act of 2009, approved October 13, 2009. Physician-owned hospitals that have a Medicare provider agreement on or before November 1, 2009, would be grandfathered subject to limitations on expansions of licensed beds, operating rooms or procedure rooms, and new disclosure requirements. A House of Representatives bill would require physician-owned hospitals to have had an active Medicare provider agreement by January 1, 2009, in order to be grandfathered. See America's Affordable Health Choices Act of 2009, H.R. 3200, July 14, 2009.
12 See An Analysis of Recent Growth of Ambulatory Surgical Centers Final Report, prepared by KNG Health Consulting LLC for ASC Coalition, June 5, 2009.
13 See America's Affordable Health Choices Act of 2009, H.R. 3200, July 14, 2009.

October 20, 2009

Business Law Update

Physician-Hospital Integration as a Business Model
By Matthew Albers*

Over the past few years, the healthcare industry, specifically hospitals and health systems, have increased their activity in acquiring, establishing, and operating physician practices. Unlike a similar trend that occurred in the mid 1990s, current hospital and health system attempts to acquire physician practices are not limited to ownership of primary care and internal medicine practices. Rather, in addition to continued interest in acquiring primary care, hospitals and health systems now target specialty physician services as well, most commonly oncology, cardiology, and orthopedics. The question arises whether legislative reforms will slow or reverse the current trend toward physician employment as part of larger, integrated hospitals and health systems.

Hospital and Health System Ownership of Physician Practices: Historic and Emerging Trend

In response to the belief that the capitation payment model of managed care would take hold in the early to mid 1990s, hospitals and health systems across the country began large scale initiatives to acquire, maintain, and operate primary care, family, and internal medicine physician practices.1 As a result, hospitals and health systems had to create complex legal and corporate structures to allow for their ownership of physician practices, especially in states maintaining a prohibition on the corporate practice of medicine.2

As the difficulty and cost of simultaneously managing physician practice and hospital operations began to outweigh the financial benefits of ownership, hospitals and health systems began to unwind these arrangements.3 This resulted in the re-emergence of the independent physician practice and presented hospitals and health systems with the difficult task of identifying and implementing alignment and affiliation structures with independent physicians. Simultaneously, certain physicians and hospitals began aggressively exploring joint venture and partnering opportunities to jointly own and operate numerous types of facilities and services, including ambulatory surgical centers, diagnostic imaging and laboratory facilities, specialty hospitals, and whole hospitals. With this focus on hospital/physician business collaboration and entrepreneurship came increased regulatory scrutiny.4

Changes to Reimbursement

The heightened joint venture and entrepreneurial activity created increased competition among physicians and physician groups. Simultaneously, changes in the economy and government reimbursement programs began to exert financial pressure on the independent physician practice. Most significantly, from 2003-2005 physicians experienced substantial reductions in professional fee reimbursement from Medicare and most independent third-party payors.5 With this reimbursement reduction and increasingly limited opportunities to share in ownership of ancillary and technical service revenues, physicians without significant hospital or health system subsidy or support faced a difficult financial situation. The reduction in reimbursement rates did not have as profound an impact on hospitals and other technical service providers. However, increased competition in the marketplace (including competition from physician-owned diagnostic and other surgical facility ventures) and dilution of the primary care physician base prompted hospitals and health systems to re-evaluate the benefits and disadvantages of physician employment, integration, and consolidation.

The Emergence of Hospital Employment of Physicians

In an attempt to recreate the perceived success of, among others, the Mayo Clinic and Cleveland Clinic, hospitals and health systems across the country currently are acquiring and consolidating hospital facilities and establishing large, integrated physician groups.6 The advantages of the integrated physician hospital structure for both sides are relatively clear. From the hospitals' perspective, alignment and employment provide:

  • Increased coordination of care and quality oversight;

  • Additional negotiating leverage with insurance payors;

  • Opportunity to better manage and control physician productivity and utilization of hospital and system resources and facilities;

  • Ability to better market and brand major service lines (i.e., cardiology, oncology, etc.);

  • More efficient management of call and emergency coverage schedules;

  • Defense against competition from physician-owned ancillary services, surgery centers, and other facility provider services; and

  • Relief from certain regulatory restrictions regarding hospital/physician relationships and prohibitions on managing physician referral practices.7

For physicians, employment with a hospital or health system entity provides a number of advantages, including:

  • A stable financial circumstance, including, but not limited to guaranteed or fixed competitive base compensation and benefits;

  • Access to continuing and reliable malpractice coverage and, in many cases, tail insurance;

  • A practice environment free from the day-to-day burden and administrative tasks of operating and managing an independent practice; and

  • More regular work hours and shared call responsibility.

By employing the physicians, hospitals access the flexibility of the employment exceptions and safe harbors to basic state and federal fraud and abuse provisions, and gain financial and operational control over the physicians interacting with their patient base.8

Impacts of Proposed Legislative Reform

Based on proposed legislation, including a version of Senator Max Baucus' (D-MT) America's Healthy Future Act of 2009,9 which the Senate Finance Committee approved on October 13, 2009, it is reasonable to conclude that the trend of hospital/physician alignment will continue in a "reformed" healthcare economy.

The single unifying factor in all of the various proposals appears to be a primary focus on extending insurance coverage and medical services to currently uninsured or underserved populations. Interestingly, the proposals do not address the factors that contribute to decreased physician practice efficiency and increased costs--factors motivating physicians to consider hospital or health system employment or affiliation.10 Additionally, while pending reform proposals promise no reductions in reimbursement levels for physician professional services, they do not alter the fundamental business realities that, from a pure economic standpoint, increasingly weigh in favor of institutional or hospital employment.

Finally, there appears to be a perception on the part of reform proponents that large, vertically integrated hospitals and systems are better situated to maximize efficiencies and quality care.11 In light of this perception and because the reform proposals do not contemplate changes that would make it economically advantageous for a physician group or hospital to remain independent, the prevailing trend toward hospital and health system consolidation and physician employment is likely to continue.

*AHLA wishes to thank Matthew E. Albers, Esquire (Vorys Sater Seymour and Pease LLP, Cleveland, OH), for authoring this alert and sharing his expertise with other colleagues.

1 See John E. Hill, "Survey provides data on practice acquisition activity," Healthcare Financial Management. Oct. 16, 2009. COPYRIGHT 1995 Healthcare Financial Management Association; see also Casalino and November, "Hospital-Physician Relations: Two Tracks and the Decline of the Voluntary Medical Staff Model," HEALTH AFFAIRS, Volume 27, Number 5 (2008).
2 The prohibition on the "corporate" practice of medicine states that a general business corporation may not practice medicine and may not employ a physician to practice medicine. Corporations entering into such arrangements may be engaged in unlawful practice of medicine and may be operating an unlicensed facility, depending upon the particular laws of their state. "To practice a profession requires something more than the financial ability to hire competent persons . . . . It can be done only by a duly qualified human being . . . . The qualifications include . . . honesty . . . upright conscience and a sense of loyalty to . . . patients . . . [in other words] good moral character which is the prerequisite to the licensing of any professional man . . . . No corporation can qualify."- Dr. Allison, Dentist, Inc. v. Allison, 196 N.E. 799, 800 (Ill. 135). Presently, a majority of states maintain some form of the prohibition, and some even prohibit direct employment of physicians by hospital entities (e.g., Ohio, California, Texas, Colorado, Illinois, and New York).
3 See Casalino and November infra, n. i, at 1306.
4 Notably, increased scrutiny occurred in the 2003 Centers for Medicare and Medicaid Services moratorium on physician investment in specialty hospitals as well as additional limitations on the establishment and operation of physician-owned or joint-ventured facilities and designated health service providers under fraud and abuse provisions of the Stark Law and the federal Anti-Kickback Statute.
5 In 2002, the Medicare reimbursement increase was less than the estimated increase in physician practice costs associated with providing services, and in each of 2003 through 2005, the Medicare reimbursement rates actually decreased. See July 2006 Government Accountability Office Report to Congressional Committees, "Medicare Physician Services--Use of Services Increasing Nationwide and Relatively Few Beneficiaries Report Major Access Problems."
6 See id. at Exhibit 1; see also John G. Larson, PhD, "Defense vs. Offense: Hospital Employment of Physicians," Health Leaders Media, May 2, 2008.
7 This factor is an important one, as under both Stark and Anti-Kickback, hospitals and other designated health service providers are permitted to require referrals from their bona fide employees subject to certain limitations surrounding patient choice, insurance limitations, and appropriate care.
8 The integrated health system and employed physician model currently dominates in a number of markets, most notably Cleveland, OH; Greenville, SC; and Phoenix, AZ; and continues to gain momentum in other large metropolitan markets across the country. These markets include, Boston, MA; Indianapolis, IA; Minneapolis, MN; Little Rock, AK; and Orange County, CA. See Casalino and November, infra, n. i, at Exhibit 1 (citing data from the Community Tracking Study and various GAO studies).
9 The Act has not yet been assigned an official Senate Bill number, but the full text of the Chairman's Mark of the America's Healthy Future Act of 2009 can be downloaded here.
10 See Allan H. Ropper, M.D., "Health Care Reform and Clinical Culture," New England Journal of Medicine, August 26, 2009.
11 President Obama and Senator Baucus have specifically cited the examples of the Mayo Clinic, the Cleveland Clinic, Geisinger Health System, and Intermountain Healthcare. Jason Plautz, "Learning from Efficient Hospitals--How do They do it?," National Journal Online, October 5, 2009.

Business Law and Governance Practice Group Leadership
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Healthcare Reform Educational Task Force Leadership
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