Key Insights on Hospital-Physician Pay-for-Performance Valuations

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Steven T. Lawrence, a healthcare transactions lawyer at Milligan Lawless, recently had the opportunity to speak with Alexandra Higgins, a Director at VMG Health, to discuss valuations of incentive compensation related to pay-for-performance arrangements.

Steve: What are the basic methodologies that you take into account when conducting a valuation of incentive compensation related to a pay-for-performance arrangement?

Alexandra: We typically consider the three generally accepted valuation methodologies for any valuation. These approaches include the Income, Cost, and Market. All three valuation approaches may not be applicable for certain types of compensation. For pay-for-performance (“P4P”) arrangements in particular, we do not utilize the Income or Cost Approach when valuing the incentive compensation component. The Income Approach is not typically utilized when valuing P4P incentive compensation due to healthcare laws and regulations, which historically have advised against the reliance on methods which consider technical revenue, or the volume and value of referrals. The Cost Approach is not typically utilized in the analysis of P4P incentive compensation due to the difficulty in estimating costs associated with improved quality outcomes without duplicating the cost to provide the clinical services.

It should be noted that if the P4P arrangement has other compensation components (such as physician administrative services, medical director services, non-clinical management services, or on-call coverage services), other approaches may be utilized.

Steve: Is there one approach that is better than others?

Alexandra: Based on the drawbacks to the Income and Cost Approaches, as previously discussed, the Market Approach is solely relied upon when valuing P4P incentive compensation. The Market Approach is often an accurate indication of FMV when the set of services or what is being measured is comparable to the market data points.

Steve: There is a lot of talk about further healthcare reform. Does that impact valuations for P4P arrangements?

Alexandra: One of the themes of healthcare reform is improving quality of care and cost efficiency. As the healthcare system moves from fee-for-services to value-based payments, there is increased activity in hospital/physician arrangements that incentivize providers to improve quality and/or reduce costs. Healthcare reform may not have a direct impact of the valuation methodologies, but with increased activities in third party payor P4P programs and hospital-based P4P programs (created in anticipation of future changes to reimbursement), it is important to stay informed with how payors, especially the government payors, are reimbursing and incentivizing based on improved outcomes.

Steve: What advice would you give someone in preparing to get a valuation started for a P4P arrangement?

Alexandra: It is important to have a draft agreement or draft term sheet prepared. Pertinent terms that need to be detailed include: the parties entering into the arrangement, term of the arrangement, services provided by each party, proposed compensation and compensation structure, and list of quality metrics or cost savings metrics. It is difficult, but not impossible, to begin a valuation without a clear understanding of what services are being provided and how will the responsible party be compensated for those services. It is also important that the parties entering into the agreement have agreed upon the services and metrics in the agreement prior to initiating the valuation process. If the services or metrics change throughout the valuation process, the valuation will most likely need to be updated and that could affect the value of the compensation.

Steve: Given the volume of regulatory enforcement, are you seeing more valuation activity for these sorts of relationships?

Alexandra: We are seeing an increased activity in P4P arrangements between hospitals and physicians. I think this is primarily due to the anticipated reimbursement changes. However, with recent regulatory enforcement, there is certainly a spotlight on hospital payments to physicians. Given the regulatory guidelines from Stark Law and Anti-Kickback Statute and the gray area of P4P compensation arrangements, many hospitals are engaging third party valuation firms to determine the fair market value of the P4P incentive payments to physicians.

Alexandra Higgins is a director in the Professional Services Agreement Division of VMG Health. She specializes in the valuation of wide variety of agreements and agreement structures, including: administrative fees (related to management and billing and collection services), physician executive compensation, co-management compensation, shared savings arrangements, and other pay-for-performance incentive compensation. Ms. Higgins’ dedicates a large portion of her practice to consulting and valuation services related to co-management, pay-for-performance payment models, and shared savings distributions for clinical integration networks. She has valued hundreds of arrangements with pay-for-performance components. Other recent experience includes the valuation of post-transaction joint venture management, billing and collection, and managed care contracting fees for a variety of medical facilities, including free-standing emergency departments, urgent care centers, ambulatory surgery centers, imaging centers, and cancer centers. Alex graduated Magna Cum Laude from Texas Christian University with a Bachelor of Science in International Economics. She has recently been published in HFM Magazine, American Bar Association, Compliance Today, Becker’s Hospital Review, and other. She has also presented numerous times at national healthcare conferences such as HFMA National Payment Summit, Becker’s Hospital Review Annual Meeting, AICPA Health Care Industry Conference, Becker’s Annual ASC Conference.

Alexandra can be contacted at alexh@vmghealth.com or 972-616-7823.

Steven T. Lawrence is a Shareholder with Milligan Lawless. Steve is a business and healthcare lawyer with a practice focused on the legal and business needs of companies and individuals. Steve represents physicians, physician practices, medical device companies, practice management companies and other healthcare providers. Steve has extensive experience in a wide range of corporate and transactional matters, including mergers and acquisitions, licensing, securities offerings, entity formation and business structuring. Prior to joining Milligan Lawless, Steve was a shareholder at a large Phoenix-based firm, served as Corporate Counsel to SkyMall, Inc., and was Associate General Counsel to JDA Software Group, Inc. He began his legal career as a Judicial Clerk to then Chief Judge Thomas C Kleinschmidt of the Arizona Court of Appeals. Steve is listed in Best Lawyers in America for Corporate Law and Chambers USA for Corporate/M&A Law. Steve holds a J.D. With Distinction from the University of the Pacific McGeorge School of Law, Master of Laws (LL.M.) in Health Law from Loyola University Chicago, an M.B.A. from the W.P. Carey School of Business at Arizona State University and a B.S. in Business Administration from California State University, Sacramento.

Steve can be contacted at steve@milliganlawless or 602-792-3536.