FAIR MARKET VALUE & COMMERCIAL REASONABLENESS

© Husch Blackwell LLP

FAIR MARKET VALUE AND COMMERCIAL REASONABLENESS:What we have learned in the last decade from our role as Governments Consulting Experts and

involvement in Hospital Transactions

March 16, 2015

David Thompson, CPA

Kevin Walker, CPA

GOALS

Understand the Fair Market Value and Commercial

Reasonableness issues from our experience as

consulting experts and hospital transaction consultants.

Understand the best practices in the roles we have on

Fair Market Value and Commercial Reasonableness

issues.

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PARTICIPANTS TODAY

David Thompson, C.P.A.

Kevin Walker, C.P.A.

CBIZ MHM LLC

David and Kevin acted as healthcare and valuation

consultants on a number of hospital transactions cases

including those listed on the next page

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EXPERIENCE

Have spent over sixty years in healthcare and business consulting performing hundreds of transaction and valuation engagements

Today we are interested primarily in our experience as consulting experts in a number of federal cases:

U.S. ex rel. Baklid-Kunz v. Halifax Med. Center et al. (M.D. Fla.)

U.S. ex rel. Drakeford v. Tuomey Healthcare System (D.S.C.)

U.S. ex rel. Simmons v. Meridian (M.D. TN)

Other settlements

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THE THREE HATS

FOR ANALYZING TRANSACTIONS

Transaction Design and Implementation Best Practices

Risk Tolerance

Relative Benefits

Compliance Review Defensible Position

Appropriate Corrections

Litigation Defense Risk Tolerance

Reasonable Defenses

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Transaction Responsibilities

Legal Counsel – Ensure transaction is set up in a legally

compliant fashion and can give guidance on commercial

reasonableness

Valuator – Ensuring that the amounts are Fair Market

Value and can give guidance on commercial

reasonableness

Hospital Health System Leadership – Responsible for its

decisions being commercially reasonable and should

rely on guidance from Legal Counsel and Valuator far a

legally compliant transaction at a fair market value rate.

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Legal Perspectives

Hospital-Physician Transactions

A resulting legally compliant contract or transaction is the

part you can control

An ounce of prevention is worth a pound

of cure Getting the transaction done correctly up front is much

less costly than the costs of defense and/or settlement in

the future

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Legal Perspectives


Starting Documents

Letter of Intent

Non – Disclosure

Exclusivity

Confidentiality

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Legal Perspectives


Commercially reasonable relationship and transaction

start at the beginning Are the right people at the table?

When is the right time to begin due diligence or accumulate documents?

When does a transaction require an outside valuator?

When is the right time to engage and outside valuator?

Who should engage and interact with the valuator?

What policies or protocols should a Hospital/Health System have in place as it

relates to physician transactions?

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Fair Market Value Perspective

FMV is Facts and Circumstance Based

Get a grasp of the facts and circumstances

Move toward a “value”

Don’t agree to a value prior to getting the valuator involved

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Fair Market Value is a defendable position

Valuator needs to be able to defend conclusions to all

parties, but ultimately to outside challenges

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Each Transaction takes on a life of its own.

One Size Does Not Fit All

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“Value” is a range, not an exact number. The higher a

hospital pays in the risk range, the more risk.

Commercial Reasonableness, Specific Market

considerations and Risk Tolerance impact where to pay

in the risk range

Higher risk transactions require greater “rigor”

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Inappropriate reliance on market data can lead to

inappropriate conclusions. Ensure your valuator fully

understands the market data.

Ensure that a stacking review is performed

Such that the sum of all the parts In not greater than the

whole for all services

Such that a physician is not being paid twice for the same

service for doing tow things at once at full value for each.

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Practical Valuation Issues

Who does the Valuator work for in a transaction?

Ideally, the Valuator is working for the transaction and to

ensure the amounts are defendable form all challenges

Practically, the Valuator is being paid for by one party

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Practical Valuation Issues

Should both sides in a transaction get a valuation?

“Battle of the Valuators” does this facilitate a transaction that is FMV and Commercially Reasonable?

What to do when the physicians engage a non-healthcare (or non reputable) valuator? Specialization in healthcare, with its regulatory and compliance environment is a MUST

Ultimately, the Hospital has the greatest risk and will need to rely on the Valuator they trust

The existence of multiple valuation opinions can potentially later be looked at a “opinion shopping”

Ideally, the physicians anted their legal counsel need to “trust” the hospital and its valuator.

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Practical Legal Counsel Issues

What should every file have at the conclusion of a

transaction

What needs to be in place prior to closing?

What can be rounded up post closing?

Options/Considerations if one of the parties “poisons the

well” during the negotiation?

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COMMERCIAL REASONABLENESS

“Commercial Reasonableness” Definition:

An arrangement is a sensible, prudent business

arrangement from the perspective of the parties involved,

even in the absence of potential referrals.

Commercially reasonable in the absence of referrals if the

arrangement would make commercial sense if entered into

by reasonable parties even if there were no potential DHS

referrals.

Stark Exceptions apply Commercial Reasonableness

standard to agreement as a whole

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POTENTIAL FACTORSIMPACTING COMMERCIAL REASONABLENESS

Length of the term

Renewal/evergreen provisions

Termination for cause provisions

Termination without cause provisions

Full time/part-time employment

Compensation--fixed vs. production

Periodic review of compensation formula

Ability to adjust compensation/formula

Net cost of agreement to hospital

Eligibility for pension, welfare and fringe benefits

Scope of duties

Requirements for documentation (administrative vs. clinical time and amount of time expended)

Duplication of services (multiple agreements for same service)

Demonstrable need for service in community

Demonstrable need for service at hospital

Justification for non-standard provisions

(A non-exhaustive list)

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COMMERCIAL REASONABLENESS

Conceptual Framework:

Potential referrals will always exist in a hospital/physician

transaction.

But, do the terms of the asset acquisition and/or

employment/independent contractor arrangement standing

alone make legitimate healthcare business sense, or does

the arrangement only make good business sense when

you consider the value of the referrals that the hospital will

be receiving from the physicians?

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VALUATION PRINCIPLES

FMV Definition:

The value in arm’s-length transactions, consistent with the

compensation that would be included in a services

agreement as a 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, at the time of the service agreement.

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VALUATION PRINCIPLES

Cost Approach

Income Approach

Market Approach

How are these methods applied in the valuation of

physician compensation and practice acquisitions?

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CASE STUDY

HALIFAX BACKGROUND

Initial Complaint filed under seal June 16, 2009 alleging

violations of the False Claims Act, including allegations

of claims resulting from improper admissions and claims

resulting from referrals from physicians whose

employment agreements were alleged to violate the

Stark Law and the Anti-Kickback Statute.

U.S. filed its Complaint in Intervention November 4, 2011

only with respect to the Stark Law/FCA allegations

involving the Medical Oncologists and the

Neurosurgeons

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INTERVENED CLAIMS

MEDICAL ONCOLOGISTS AGREEMENTS

Numerous issues, none of which included FMV or

commercial reasonableness

Principal Stark Law issue:

Does the bona fide employee exception permit a bonus

pool that includes DHS revenue if allocated based on the

proportion of personally performed services of physicians

participating in the pool.

Held: No; employee exception only permits a bonus to a

physician based on his or her own personally performed

services.

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NEUROSURGEONS AGREEMENTS

We will discuss the valuation principles in general terms,

then review the application of these principals to the 3

agreements both for Fair Market Value analysis and

Commercial Reasonableness analysis

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COMMERCIAL REASONABLENESS ISSUES

For Most Years the Physicians’ Received 100% of their Collections

Derived from their Professional Services

Kuhn

Compensation & Profit Review Before and After Employment

Before Employment After Employment

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Practice Receipts 826,042 1,234,975 1,212,453 1,020,449 900,985 923,741 1,114,911 1,268,106 1,138,702 1,227,211 1,063,597 844,683 754,396

W-2-Compensation 150,000 160,000 187,021 185,898 587,173 1,078,793 1,032,523 1,253,335 1,217,137 1,154,989 1,154,921 1,186,346 1,086,541

Sub S Distribution 357,508 682,767 564,638 306,411

Total Compensation 507,508 842,767 751,659 492,309 587,173 1,078,793 1,032,523 1,253,335 1,217,137 1,154,989 1,154,921 1,186,346 1,086,541

Compensation as a % of Receipts 61.44% 68.24% 61.99% 48.24% 65.17% 116.8% 92.6% 98.8% 106.9% 94.1% 108.6% 140.4% 144.0%

Average Compensation % of receipts before employment 59.98% Average Compensation % of receipts after employment 107.50%

Average Compensation before employment 648,561$ Average Compensation after employment 1,083,529$

Average Collections before employment 1,073,480$ Average Collections after employment 1,026,259$

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HSI Incurred Material Financial Losses related to the

Neurosurgeons’ Practices

Physician

Income (Loss) After

Physician's Salary

and Benefits

Practice

Expenses

Direct

Practice

(Loss)

Facility

Contributio

n Margin

Overall

Neurosurgeon

Margin

Khanna $(338,853) $ 220,663 $(559,516) $2,412,176 $1,852,660

Vinas $(413,013) $ 388,626 $(801,639) $2,797,650 $1,996,011

Kuhn $25,949 $ 437,717 $(411,768) $3,116,078 $2,704,310

Total $(725,917) $ 1,047,006 $(1,772,923) $8,325,904 $6,552,981

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On-call Arrangements:

The neurosurgeons received $1,100 each day they were on call, rather

than for “excess call.”

Inherent in a physician’s total compensation, included in survey data,

is an expectation to provide “normal call,” generally considered to be

every 4 or 5 days.

Paying for “normal call” is unusual and not commercially reasonable.

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The Neurosurgeons were Favorably Treated in Comparison to Other Employed HSI Physicians

On a HHMC spreadsheet outlining the neurosurgeons’ compensation arrangements, the following was noted:

“Additional subsidy not provided to other physicians:

200% of the Medicare Fee Schedule for all trauma patients

Reimbursed for hospital employees workers comp claims

Collection expense is not deducted from collections

Bad debt expense is not deducted from collections

80% of the Medicare fee schedule for district charity and self-pay patients like non-employed physicians.”

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The Neurosurgeons were Favorably Treated in Comparison to Other Employed HSI Physicians The neurosurgeons received a car allowance totaling $10,800

per year. No other HSI employed physician received any car allowance. When Dr. Kuhn practiced as an independent physician, his car expenses were much lower and ranged between $1,482 and $2,877 for the years 2000 through 2002. In later years Dr. Vinas’ car allowance was increased to $13,500 per year.

For those years that HHMC’s Federal Form 990s were produced, each 990 listed each of neurosurgeons as one of the five highest paid employees.

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0

200000

400000

600000

800000

1000000

1200000

1400000

1600000

1800000

2000000

Dr. Khanna Dr. Kuhn Dr. Vinas MedicalOncology

RadiationOncology

GynecologyOncology

Urology Intensivist

Neurosurgeons Compared to Other Employed PhysiciansActual CY 2008 Compensation

Physician Group Compensation

is for highest paid physician

in the group.

MGMA 90th percentile for

Neurosurgery

With the exception of medical oncologists, the Neurosurgeons were the only employed specialist group who earn

compensation above or near the 90th percentile levels.


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VALUATION PRINCIPALS

Market Approach

Industry Weighted Average Median 75th Percentile

Neurosurgery 2011 552 66.43$ 84.73$

Neurosurgery 2010 523 63.72$ 80.00$

Neurosurgery 2009 439 65.25$ 85.72$

Neurosurgery 2008 214 66.08$ 85.52$

Market Data-Compensation Per WRVU

Industry Weighted Average Median 75th Percentile

Neurosurgery 2011 353 75.4% 104.1%

Neurosurgery 2010 366 68.3% 97.5%

Neurosurgery 2009 314 52.1% 96.6%

Neurosurgery 2008 150 68.0% 81.4%

Market Data-Compensation as a % of Collections

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FMV RESULTSVinas

Neurosurgeon- Start Date-February, 2000

Total Compensation v Market Data

Specialty-Neurosurgery-Actual Pay

Year Vinas Vinas 1099-Misc Total

2011 1,430,798$ 1,430,798$ >90th

2010 1,617,383$ 1,617,383$ >90th

2009 1,933,717$ 1,933,717$ >90th

2008 1,896,437$ 1,896,437$ >90th

2007 1,443,407$ 1,443,407$ >90th

2006 1,984,833$ 1,984,833$ >90th

2005 1,440,589$ 1,440,589$ >90th

2004 1,098,403$ 81,500$ 1,179,903$ >90th

2003 1,004,248$ 5,437$ 1,009,685$ >90th

2002 951,365$ 51,861$ 1,003,226$ >90th

2001 n/a 46,500 46,500$

2000 n/a 32,000$ 32,000$

Source W-2's 03328250-259 0341706, 0341699

0341710, 0341695,

0341693

Median 75th % 90th % Median 75th % 90th %

979,846$ 792,887$ 602,130$ 254% 196% 159%

1,349,839$ 1,155,934$ 967,155$ 331% 249% 200%

1,334,369$ 1,152,506$ 968,389$ 337% 255% 204%

Industry Weighted Average Number Median 75th 90th

Neurosurgery 2010 919 637,537$ 824,496$ 1,015,253$

Neurosurgery 2009 835 583,878$ 777,783$ 966,562$

Neurosurgery 2008 726 562,068$ 743,931$ 928,048$

Market Data- Total Compensation

Excess over Market

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FMV RESULTSKhanna

Neurosurgeon- Start Date-July 7, 2001



Year Khanna

Khanna 1099-

Misc Total

2011 1,134,951$ 1,134,951$ <90th

2010 1,107,519$ 1,107,519$ <90th

2009 1,506,217$ 1,506,217$ >90th

2008 1,724,600$ 1,724,600$ >90th

2007 1,714,064$ 1,714,064$ >90th

2006 1,910,913$ 1,910,913$ >90th

2005 1,709,902$ 1,709,902$ >90th

2004 1,302,879$ 49,000$ 1,351,879$ >90th

2003 1,466,661$ 22,000$ 1,488,661$ >90th

2002 780,186$ 43,500$ 823,686$ <90th

2001 n/a

2000 n/a 58,500$ 58,500$

Source W-2's 03328210-219

0341691,

0341702-3&

0341707


469,982$ 283,023$ 92,266$ 178% 138% 112%

922,339$ 728,434$ 539,655$ 190% 142% 115%

1,162,532$ 980,669$ 796,552$ 268% 202% 162%



Neurosurgery 2010 919 637,537$ 824,496$ 1,015,253$

Neurosurgery 2009 835 583,878$ 777,783$ 966,562$

Neurosurgery 2008 726 562,068$ 743,931$ 928,048$

Excess over Market

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FMV RESULTS

$ Compensation Over (Under)

Kuhn

Neurosurgeon- Start Date-February 14, 2003



Year Kuhn

Kuhn 1099-

Misc Total

2011 1,086,541$ 1,086,541$ <90th

2010 1,186,346$ 1,186,346$ <90th

2009 1,154,921$ 1,154,921$ >90th

2008 1,154,989$ 1,154,989$ >90th

2007 1,217,137$ 1,217,137$ >90th

2006 1,253,335$ 1,253,335$ >90th

2005 1,032,523$ 1,032,523$ >90th

2004 1,032,407$ 46,386$ 1,078,793$ >90th

2003 504,302$ 82,871$ 587,173$ <75th

2002 n/a 158,363$ 158,363$

Source W-2's 0338220-228

0341708,

0341701,034

1704


548,809$ 361,850$ 171,093$ 170% 132% 107%

571,043$ 377,138$ 188,359$ 203% 153% 123%

592,921$ 411,058$ 226,941$ 205% 155% 124%

Actual Compensation % of Market



Neurosurgery 2010 919 637,537$ 824,496$ 1,015,253$

Neurosurgery 2009 835 583,878$ 777,783$ 966,562$

Neurosurgery 2008 726 562,068$ 743,931$ 928,048$

Excess over Market

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-

5,000

10,000

15,000

20,000

25,000

30,000

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Vinas WRVUs

Vinas Median 75th

-

5,000

10,000

15,000

20,000

25,000

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Kuhn WRVUs

Kuhn Median 75th

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ADDITIONAL FACTORS

Physicians’ Time Analysis: E&M codes, for instance, critical care codes, are time based codes for which a physician’s time must be

documented in the medical record. Physicians routinely determine which level of E&M to code based on the amount of time they spend with a patient. Generally, more time spent with a patient equates to a higher level code, and higher reimbursement levels.

Neurosurgeons’ WRVUs associated with E&M services were compared to WRVUs reported by family practice physicians (because almost all of a family practice physicians’ work is associated with E&M services). Each of the neurosurgeon’s E&M services alone are positioned near or materially above the median levels reported by full time family practitioners. In 2007, Dr. Khanna’s WRVUs associated solely with his E&M services were 3.25 times higher than a full time family practice physician at the median level and more than 2 times higher than 90th percentile amounts. This means that even without accounting for all of the time he spent in surgery, Dr. Khanna billed over three times more for his E&M services than the median family practice physician.

HHMC engaged an independent consultant to perform a practice analysis for Dr. Vinas and Dr. Kuhn. After analyzing each of the physicians WRVUs by CPT code, one of the consultant’s findings was that Dr. Vinas was working an estimated 8,749 hours a year, and Dr. Kuhn 6,931 hours a year (there are 8,760 hours in a 365 day year). By using 2,080 hours to equate the consultant’s estimated hours to full time equivalents (“FTEs”), this equals 4.2 FTEs and 3.33 FTEs, respectively. An internal HHMC email showed that through August 2010, Dr. Khanna had taken 55 days off, Dr. Vinas 38 days and Dr. Kuhn 22 days off for the year.

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ADDITIONAL FACTORS

Physicians' E&M Codes Only Market Data-Family Practice % of Market Median % to 75th Percentile

Vinas Kuhn Khanna Survey N Median 75th 90th Vinas Kuhn Khanna Vinas Kuhn Khanna

2011 4,588 4,971 3,424 Family Practice (without OB) MGMA 2012 4886 4,815 5,897 7,082 95.29% 103.24% 71.11% 77.80% 84.30% 58.06%






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REPORT CONCLUSIONS

I believe that the compensation terms of the employment agreements and HSI’s business arrangements with the neurosurgeons were not commercially reasonable because absent the physicians’ referrals to HHMC, there does not appear to be a legitimate business purpose for entering into or maintaining the described physician employment agreements. In my opinion, the employment agreements do not make commercial sense, and would not have been entered into by a reasonable entity of similar type and size.

Based upon my findings I believe that HSI paid Drs. Vinas and Khanna in excess of fair market value for their services for each year examined. Except for the years 2003 and 2008, Dr. Kuhn’s compensation also appears to fall outside the fair market value range.

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VALUATION CONCLUSION

Based upon my findings I believe that HSI paid Drs.

Vinas and Khanna in excess of fair market value for their

services for each year examined. Except for the years

2003 and 2008, Dr. Kuhn’s compensation also appears

to fall outside the fair market value range.

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WRAP-UP

QUESTIONS

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CONTACT INFO

CBIZ MHM, LLC

David W. Thompson | Managing Director

p: [email protected]

Kevin Walker | Managing Director

P: 913-234-1023

[email protected]

CBIZ MHM, LLC11440 Tomahawk Creek Parkway Leawood, KS 66211

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mailto:[email protected]

DAVID W. THOMPSON, C.P.A.

KEVIN WALKER, C.P.A.

David Thompson: has over 35 years of healthcare experience and has

reviewed or prepared hundreds of healthcare valuations, including those for

hospital/physician acquisition, employment or professional services transactions,

surgical hospitals, ambulatory surgery centers, imaging centers, clinical and

pathology labs, cardiac cath labs and physician practices.

Kevin Walker: has over 25 years of healthcare experience has reviewed or

prepared hundreds of healthcare valuations, including those for hospital/physician

acquisition, employment or professional services transactions, surgical hospitals,

ambulatory surgery centers, imaging centers, clinical and pathology labs, cardiac cath

labs and physician practices.

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FAIR MARKET VALUE & COMMERCIAL REASONABLENESS

Health & Medicine

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