PYA Presentation: “Thorny Issues in FMV and Commercial Reasonableness"

April 16, 2014
Prepared for Greater Kansas City Society of Healthcare Attorneys
“Thorny Issues” in
Healthcare Valuation
W. James Lloyd, CPA/ABV, ASA, CFE
Principal, PYA
W. Lyle Oelrich, MHA, FACHE, CMPE
Principal, PYA
April 16, 2014

April 16, 2014
Agenda
• Hypothetical Case Study Scenario
• Regulatory Framework – Definitions
– Fair Market Value
– Commercial Reasonableness
• Key Concepts and Thorny Issues
– Business Valuation
– Compensation Valuation
• Commercial Reasonableness vs. Fair Market Value
• Questions and Answers

April 16, 2014
• 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 PT, DME, imaging, and an ASC.
• Ancillary services represent 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

April 16, 2014
Hypothetical Case Study Scenario
• 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 practice.
– 25% increase in the physicians’ post-transaction compensation.
• Hospital’s general counsel requests an independent commercial
reasonableness assessment and fair market value opinion before signing
off on the transaction.

April 16, 2014
Regulatory Framework
Stark Law – Fair Market Value
• Fair market value means the value in arm's-length transactions, consistent with the general
market value.1
• "General market value" means the price that an asset would bring as the result of bona fide
bargaining between well-informed buyers and sellers who are not otherwise in a position to
generate business for the other party, or the compensation that would be included in a
service agreement as the result of bona fide bargaining between well-informed parties to
the agreement who are not otherwise in a position to generate business for the other party,
on the date of acquisition of the asset or at the time of the service agreement.2
Internal Revenue Service Revenue Ruling 59-60 – Fair Market Value
• The price at which the property would change hands between a willing buyer and a willing
seller when the former is not under any compulsion to buy and the latter is not under any
compulsion to sell, both parties having reasonable knowledge of relevant facts.
1 Estate Tax Reg. 20.2031.1-1(b); Revenue Ruling 59-60, 1959-1, C.B. 237.
2 Federal Register / Vol. 69, No. 59 / Friday, March 26, 2004 / Rules and Regulations.

April 16, 2014
Regulatory Framework
Commercial Reasonableness
• Department 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 size and a reasonable physician of similar scope and
specialty, even if there were no potential designated health services (“DHS”) referrals.”
• OIG Threshold3
– Compensation arrangements with physicians should be “reasonable and necessary.”
1 63 Fed. Reg. 1700 (Jan. 9, 1998).
2 69 Fed. Reg. 16093 (March 26, 2004).
3 “OIG Compliance Program for Individual and Small Group Physician Practices,” Notice, 65 Fed. Reg. 59434 (Oct. 5, 2000); OIG Advisory Opinion No. 07-10,
September 20, 2007, pg. 6, 10; “OIG Supplemental Compliance Program Guidance for Hospitals,” Notice, 70 Fed. Reg. 4858 (Jan. 31, 2005).

April 16, 2014
Key Concepts and Thorny Issues:
Business Valuation
Valuation Methodologies:
- Income Approach
o Discounted Cash Flow (“DCF”) Method
o Capitalized Income (“CapInc”) Method
- Market Approach
o Merger & Acquisition Transactions Method
o Guideline Public Company Method
- Cost Approach
o Net Asset Value (“NAV”) Method

April 16, 2014
Business Valuation
Attributing substantial value to intangible assets of a
physician practice without sufficient cash flow to support
from an income approach perspective (i.e., no economic
benefits to support the intangible asset).
- Sum of the parts (tangible and intangible assets from using
the cost approach) should generally not be greater than the
whole enterprise value determined from the income or
market approaches.

April 16, 2014
Business Valuation
Bifurcating and separately valuing the professional and
ancillary components of a physician practice using
different methodologies with a resulting combined
value substantially in excess of the value resulting from
either method individually.
- e.g., using the DCF method to value the ancillaries and
the NAV method to value the remaining (i.e.
professional services) portion of the practice with a
combined value > the results from using the DCF or
NAV methods for the whole practice.

April 16, 2014
Business Valuation
Post-transaction physician compensation should be
taken into account when valuing a physician practice.
Otherwise, there is potential for double counting the
same benefits.
Buyer synergies (such as provider-based
reimbursement rates) generally should not be taken
into account if the standard of value is “fair market
value.”

April 16, 2014
Hypothetical Case Study
(Application)
• 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 combined = the $20M purchase price.
• However, the value of the combined practice using either of the DCF or
NAV methods was substantially less.
– Reason: No physician compensation expense included in the ancillary cash flow
projections; however, the ancillary cash flows contributed significantly to the physicians’
historical compensation.

April 16, 2014
Compensation Valuation Methodologies
Compensation Valuation
Income Approach –
sum of present
values of expected
future benefits
Market Approach –
comparison to what
is actually being paid
in the market place
(e.g., published
surveys)
Cost Approach –
value underlying
assets or resources
(e.g., cost-to-replace,
cost-to-recreate)

April 16, 2014
• Productivity
• Experience
• Service type (e.g., clinical vs. admin)
• Supply/demand
• Benefits
• Credentials
• Specialized training (e.g., robotic surgery)
• Other
Factors
Considered:

April 16, 2014
• Using multiple, objective surveys remains a
prudent practice for determining fair market
value compensation.
• Data:
– Definitions
– Tainted?
– Regional variations
– Outdated?
– Cherry-picking
– Sample size
Published
Surveys:

April 16, 2014
• On-Call Pay for Employed Physicians
- Origin of on-call pay (limited to no payment for service)
- Benchmark data vs. employed compensation physician formula
- Simultaneous, multiple campus coverage
• Challenges With Work Relative Value Unit (“wRVU”)
Models
- Base plus wRVU threshold/compensation per wRVU
- 2009 MGMA Study: Relationship between compensation and
compensation per wRVU
- “Reported” vs. “Calculated”

April 16, 2014
• Illogical Part-time Employment Arrangements
- Benefits
- Exclusivity
- Compensation Model
• Stacked Compensation
- Bundle of services (i.e., each part and the whole)
- Duplication of payment
- Misinterpretation of benchmark data

April 16, 2014
Commercial Reasonableness vs.
Fair Market Value
Commercial reasonableness is different than fair
market value
Does the transaction make cents sense?
Was this a good business arrangement to enter into in
the first place?
Is there a legitimate business reason to enter into this
agreement?
Did we contract with the most appropriate provider
without duplicating facility need?
Do the underlying economics of the transaction make
sense?
Fair Market Value
(NARROW)
Commercial Reasonableness (BROAD)
What is the range of
dollars you are going to
pay for the
space/services?

April 16, 2014
Commercial Reasonableness vs.
Fair Market Value
Thus, FMV assesses the reasonableness of the
“range of dollars” while CR looks to the
reasonableness of the business arrangement as a
whole.
Accordingly, a transaction or arrangement may be at
fair market value but not commercially reasonable.

April 16, 2014
PYA’s Approach for Evaluating
Refer to Commercial Reasonableness Outline Handout.
PYA
Analysis
Business Purpose Analysis
Provider Analysis
Facility Analysis
Resource Analysis
Independence & Oversight Analysis

April 16, 2014
Business Purpose Analysis
Does the proposed arrangement represent a reasonable necessity that is
essential to the functioning of the hospital or other healthcare provider?
Is the proposed arrangement reasonably necessary to accomplish a rational
business purpose?
Is the specific purpose of the arrangement clearly identifiable and
appropriately defined?
Do the proposed services relate to the business and/or clinical plans and
strategies of the healthcare provider?
Do relevant national, regional, and local economic conditions exist that may
affect the appropriateness of the proposed arrangement?
Do the proposed services contribute to the provider’s profits and/or the
development of a particular service line without requiring income from
proscribed referrals?

April 16, 2014
Provider Analysis
Does the proposed arrangement require a physician to perform the services?
Does the proposed arrangement require a physician of a certain specialty to
perform the services?
Does any specialized training and/or experience of the provider exist that
should be taken into account when evaluating the proposed arrangement?
Are the particular nature of the duties and corresponding amount of
accountability associated with the proposed arrangement clearly defined and
reasonable?
Is the amount of time demanded of the physician under the proposed
arrangement reasonable?
Do any salary considerations exist that should be evaluated in relation to
providers of similar specialty and experience in comparable organizations and
positions?

April 16, 2014
Facility Analysis
Are patient demand, the number of hospital patients,
and/or the community need sufficient to justify the
services?
Are patient acuity levels such that the proposed services
are necessary?
Do patient needs dictate the necessity for a separate and
distinct provider for the proposed services?
Are the size of the hospital and the relevant department
appropriate for the proposed services?

April 16, 2014
Resource Analysis
Is the proposed arrangement a necessary addition to the
managerial and administrative efforts already required by
the medical staff bylaws?
Have the number of committees and/or meetings that
otherwise require physician attendance outside of the
proposed arrangement been considered?
If the healthcare entity is part of a larger health system, do
patient care protocols and procedures exist that can be
coordinated among its facilities in lieu of the proposed
arrangement?

April 16, 2014
Independence and Oversight
Analysis
Does the healthcare entity have and subsequently use its performance assessments to
determine whether new or existing provider arrangements should be reduced (e.g.,
hours condensed) or eliminated?
Does the entity maintain a formal process for executive management and legal counsel
to review and approve the proposed arrangement?
Does the provider engage in appropriate monitoring to determine:
• Whether services specified in similar arrangements are actually performed?
• The total amount of funds spent for such services?
• A verifiable outcome resulting from the arrangement?
Does sufficient independence exist related to the board or committee that establishes
the proposed arrangement?
Is there a written agreement that addresses the terms of the proposed arrangement?

April 16, 2014
Examples of Potentially Commercially Unreasonable Arrangements
• A multi-hospital health system requires specialty specific telephonic
call coverage and engages one physician at each campus to be on
24/7 call the same day.
• An employment agreement that incorporates a payment for quality
without the ability to track improvement in patient care.
• A hospital paying a cardiologist a cardiology-specific compensation
rate for administrative work requiring only a primary care physician’s
skills.
• A hospital failing to maintain proper oversight of the effectiveness
and necessity of its physician services arrangements. For example:
- Calculating wRVUs (generally for personally performed services –
should be modifier-adjusted).
- Not performing quarterly, semi-annual, or annual contract
reconciliations when required by the arrangement.

April 16, 2014
Hypothetical Case Study
(Application)
• Questions
– Is it commercially reasonable for the hospital to pay $20M upfront for the
practice utilizing a bifurcated valuation approach 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 by the ancillary services they anticipate selling to the
hospital for $20M?

April 16, 2014
Contact Information
Jim Lloyd, CPA/ABV, ASA, CFE
Principal, Pershing Yoakley & Associates, P.C.
(865) 673-0844
jlloyd@pyapc.com
Lyle Oelrich, MHA, FACHE, CMPE
Principal, Pershing Yoakley & Associates, P.C.
(865) 673-0844
loelrich@pyapc.com

PYA Presentation: “Thorny Issues in FMV and Commercial Reasonableness"

Recommended

Recommended

More Related Content

What's hot

What's hot (20)

Viewers also liked

Viewers also liked (6)

Similar to PYA Presentation: “Thorny Issues in FMV and Commercial Reasonableness"

Similar to PYA Presentation: “Thorny Issues in FMV and Commercial Reasonableness" (20)

More from PYA, P.C.

More from PYA, P.C. (20)

Recently uploaded

Recently uploaded (20)

PYA Presentation: “Thorny Issues in FMV and Commercial Reasonableness"