Executive Session: The need to "identify, quantify and justify" practice losses in HOPDs

MGMA · Executive Session: Making Sense of Stark and Practice Losses (Part 2)

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On Dec. 2, 2020, the Centers for Medicare and Medicaid Services (CMS) published a Final Rule titled “Modernizing and Clarifying the Physician Self-Referral Regulations.” This rule makes a number of modifications to the regulations implemented in physician self-referral, or Stark Law.

MGMA’s Government Affairs Office has closely monitored the new rule and has published advocacy letters and statements describing how the new rule will affect MGMA members.

In this Part 2 of my special two-part episode of Executive Session, I talk again with Tim Smith, CPA, ABV, principal in TS Healthcare Consulting, a firm that focuses on valuing healthcare organizations and providing guidance on federal regulations, including Stark Law. Tim has authored numerous articles for MGMA and has also spoken at MGMA conferences.

What follows is a transcript of this episode’s conversation:

DAVE GANS: In fact, as we talk about losses, maybe we should get into some of the depth, a little bit more discussion on why hospital-based practices will lose money. I think this last section in the Federal Register gave some of the intangible reasons, but there are also some fundamental reasons on what happens internally to a hospital-based practice, and how they differ from practices that are independent or those that may have a different type of owner, for example, an investment capital company owning the practice, because they operate in a very different environment than if they’re hospital based.

I've looked at the information from the MGMA DataDive Cost and Revenue for years, and we see that a hospital-owned practices typically have substantially lower revenue, they have lower operating costs, but similar provider compensation levels. And therefore, they will, oftentimes on their books, show a substantial loss of internal financial reports. However, because of other circumstances, the health system still finds it necessary to have these practices as part of the system. And there are other elements of revenue that may accrue in the health system, even though it doesn't show in the books of the practices that they own. Can you give some of your thoughts on what is happening here? And then we'll go into a little bit more depth as we go along.

TIM SMITH: Sure. And you know, Dave, I think that you and I are the two guys in this industry that have probably published and spoken the most about practice losses. I ran across one of your articles in 2011 that I cited about this subject, and I know I started speaking about it at conferences and started writing and publishing in 2012, and I've written a lot about it.

I want to start off here by talking about how you're right, different buyers think about physician-owned practices differently. Generally speaking, the physicians are focused on maximizing their earnings to play out for physician comp, right? Along with kind of their own desires about, you know, lifestyle considerations and so forth. Obviously, meeting community need and patient care are key to physicians; they're healers, that's what they do. You know, that's their focus. We're going to operate this practice to maximize our earnings within these other considerations. Private equity, for them, it's about developing a cash flow stream, and the idea of building a platform from which they can grow the business, you know, probably some of them are flippers. There's different types of private equity firms that have different strategies, but eventually, they're going to sell it to somebody else downstream; they want to grow it and make money off that. But they offer physicians different things. You know, there’s lots of webinars and things you can read about that. Hospitals are very different, in that they come in, and physician practices become part of this integrated delivery network concept. And, you know, for them, it's about offering a continuum of care, having geographic scope. Many times, they'll employ the physicians because the markets won't sustain physicians, so for community need purposes, they have to hire the physicians, for example. And so you're right, these different types of buyers have different outlooks, and they do different things with the practices. If you bring in the payers, my understanding from reading the press is that a lot of the payers buy physician practices to control referrals, not referrals to the payer system, but to try to do low-cost referrals. They want their doctors referring the patients to high-quality, low-cost care for ailments, and that was one of their ways to try to keep the cost of healthcare down relative to premiums.

So, as you can imagine, you've got these four different types of buyers and employers of physicians who think about them very differently.

And you're absolutely right, they're going to do things operationally and strategically very different with their practices, and you're going to get different financial outcomes as a result of that. So, I think it's important to understand that these different buyers, and owner-operators is the term we'll use in the valuation world, operate these practices differently.

So, let me give you three keys to how to think about practice losses, particularly for health systems. I think the first key is that there can be many causes for practice losses, I often see people trying to focus on one issue. In my investigations and examinations of why they lose money, and talking to operators, etc., over the years what I found is, there's a whole bunch, and everybody tends to want to focus on one. And I would say, for every health system out there that's losing money on their docs, there's probably five things that contribute to the losses. So that's the first key. The second key is that losses are facts and circumstances based. I can list out a whole bunch of reasons. I forget how many, you know, there's a dozen of them, or something, that we could go through as to why they lose money. But whether or not those apply to your specific physician groups is all facts and circumstances based. So, number two, be facts and circumstances based in your thinking. And the third is that you’ve got to quantify the amount of the loss contributed by that factor. In many ways, if you can't source the loss by quantifying it, I think you have to question whether or not you can claim that, well, this factor is actually contributing to our losses. Because if you can't quantify it…and I'm a numbers guy, I'm a bean counter, I'm a CPA. I would tell you, if you can't quantify it, I'm not sure you can claim that's a reason why you lose money. And so, I think, you know, multiple causes, fact specific, and quantifying the losses are really the three keys. That's the fundamental conceptual framework that you need to start with when you look at losses for your organization.

DAVE GANS: Yeah. Earlier, I mentioned that in looking purely at the data MGMA publishes in our Data Dive for cost and revenue, that we see hospitals having lower operating costs, lower revenue, and we'll talk about those in a minute, what happens there. But the most interesting element is, of course, in order to recruit and retain physicians, hospital systems need to pay a competitive or market compensation to their doctors. Now, in a private practice environment, it's a very simple equation. The doctor’s compensation is what remains after all the expenses are paid from the revenue the practice receives, because it's a closed system. But in the practices that are part of a health system, it's an open system. That the health system can subsidize those practices, so even if they run at an operating loss, they can compensate their doctors based on the so-called market value of the compensation environment to recruit a doctor of that caliber specialty and the like. Can you give some of your thoughts on what has happened in the hospital compensation environment that almost requires that hospital to make sure they're paying a competitive compensation level to recruit and retain doctors?

TIM SMITH: Yeah, and this is, I think, a real key point to beginning to talk about losses, and as you know, Dave, we’ll talk about a whole lot more. But starting off with, I would say there's a mindset in the industry on the hospital side, which is when we think about fair market value compensation, we immediately run to survey data. And we tend to immediately run to certain percentiles of survey data. And if you go hire a bunch of valuation people or valuation consultants, comp consultants, they're all going to come in and focus on survey data. And that's the mindset of the hospital side. Well, that's not the mindset of the physician-owned practices or private equity, because they have to basically live within their means, as you've talked about.

But I would say that one of the first causes that people have to understand is that if you simply go pull the median, or the 65th percentile, or whatever, out of any survey data compilation, you've basically ignored…if that's your starting point and your ending point, and notice how I said starting point and ending point, because I'm talking about the exclusive use of survey data to set physician compensation…if you do that, you fundamentally ignore the economics of your practice and your local market. And I would say one of the first causes is that health systems start and finish with survey data, and they're done. And here's the problem, nobody knows that the median doctor for a specialty in, let's say MGMA or any of the other surveys, nobody knows anything about that doctor. We might know what that doctor’s production is, but we don't know anything about their operating environment. That operating environment may be very different than a health system’s subject doctor practice. And so, if you base everything solely off of survey data and bring that into your physicians, you may end up with a loss because that compensation can't be sustained in your market, or if you add in other factors that can't be sustained. But the starting point, I think, if you want to really begin to understand your losses, is looking at what are the economics? What are we bringing in for revenue? And what are we charging for overhead? Let's start there, and then begin to ask ourselves questions about are we sufficient to recruit doctors, and things like this; we can talk more about this later.

The 65th percentile may or may not be sustainable in your market; it may be too low. I know of markets in the United States where the reimbursement is so high that the 65th percentile is a massive pay cut for doctors, because for the earnings in those markets, the revenue is there. And I'll point out that CMS was made aware of how the hospital physician industry sector has become so focused on percentiles of survey data. And people thought that CMS and the government believe that, let's say up to the 75th percentile, was FMV. CMS came out, in the regs and in its commentary, and just really disavowed and disclaimed all of this favored percentile business for FMV. They said there is no such policy, for example, that the 75th percentile is this kind of rubicon, where anything above is not FMV and anything below is FMV, and they kind of disclaimed what the industry had attributed to CMS, and/or the government. Although, if you look at the case history with Tuomey, that's the position the government took with its expert. But that's a change in mindset that I think the industry is going to have to get used to, or think about going forward.

DAVE GANS: That was the compensation formulas used by hospitals in order to compensate their employed physicians. There are other factors, and we alleged earlier that hospital practices have less revenue. Now, I think the number one reason we see for less revenue happens to be part of their billing compensation, which we'll talk about, but also it's because physicians who are working in health systems, when we look at the production of those doctors, that in past years, physicians, oftentimes as part of a health system, may have not had the same compensation formulas that rewarded productivity, like what we see in the private sector. So, can you just give some of your thoughts and observations about what happens for physician productivity in both hospital system as well as independent practices, and how this affects the total revenue to the organization, which is the top line in this equation.

TIM SMITH: I think that's one of the areas that is another big contributor to losses. The fact that most health systems will convert what would have been the in-office ancillaries, diagnostic tests, various therapies, and so forth, they'll convert those and move them out of the in-office setting and over to a hospital outpatient department setting, because the site of service differential and reimbursement is so much better and higher for Medicare, as well as many of the commercial payers, that they'll do that.

Now, I think what folks have to understand is that for many specialties, physician compensation for that specialty is in fact underwritten by the profits or net earnings from those ancillary services. So, let's think about a noninvasive cardiologist, who is in the office doing cognitive diagnostic work that consists of a lot of E/M codes, essentially. Office visits coupled with reviewing various diagnostic tests in order to form a treatment plan. Those physicians make a lot more than their peers, let's say their internal medicine peers that simply just see patients all day in the office doing the same sort of E&M codes on a day-to-day basis. But the noninvasive, cardiologists make a lot more money. Why is that? Well, one reason is because they make money off all those tests, all those nuclear gamma studies and so forth.

DAVE GANS: Yeah, all those tests accrue to the total revenue of the practice that eventually is distributed. It makes sense.

TIM SMITH: Correct. And I think one of the fallacies that I see in the industry, on the hospital side in particular, and with physicians as well, is that people don't get that when it comes to doctors, there's the revenue they generate for their own professional services, and then there's this sort of byproduct of that, a natural byproduct of how they go about treating patients or these ancillary services. And that helps underwrite their compensation. For example, orthopedic surgeons would be another example of, you know, usually the groups have MRIs and all kinds of ancillaries. They may have physical therapy and other things that they do, where they'll make money off of this, and this underwrites physician comp. So when we look at various specialties, one of the explanations as to why these kinds of doctors make more than those kinds of doctors is ancillaries. But people tend to think about the profits of those ancillary services. They don't think about it as underwriting physician comp; they think about it separately. And so, when the hospitals convert it, what happens is that source of net earnings, because there's a cost associated with that as well, so we have the revenue and the cost component and then we have what's left over is the earnings, that's used to underwrite physician comp. But once you move it out of the practice, it's not there anymore. And if you pay the doctors the same, you'll lose money instantly. I mean, that's an instant source of a loss, when you do that.

DAVE GANS: And that was also, oftentimes, the excuse that was given. Now, when I've looked really closely at the data, I've seen two other factors that, even at the same degree of work that occurs, and that has to do with the payer mix of that health system-based practice, is typically the payer mix of the hospital. And that payer mix, oftentimes, is not the same as what you see in a commercial private practice. In other words, they'll have twice as much Medicaid services in a health system-owned practice, because of their community missions. And of course, Medicaid pays, oftentimes, only a fraction of the rate of commercial payers. So that's a factor. And we also can see in the revenue cycle that health systems, for various reasons, collect less of the billed charge. What do you think this means, in the context of the physician loss?

TIM SMITH: I will tell you that on the revenue side, it is very interesting. I will say first of all, with the payer mix, you're absolutely right. If you have a payer mix that has a higher level of poor payers in it than another practice, all things being equal, you're going to generate less revenue. And if you're trying to compete with your physician comp, something's got to give in that equation. You know, physician-owned practices have to live with whatever their payer mix is, which is why many times, you’ll see that payer mix be different than, let's say, a mission-driven health system. I will say, Dave, that when it comes to payer mix, that's one of those areas that I think needs to be fact specific and quantified.

I live in the Dallas-Fort Worth area, and I can tell you, it doesn't matter what organization owns a physician practice. If you're in certain communities, you're going to have one kind of payer mix. If you're in another part of the Dallas-Fort Worth metroplex, you're going to have a completely different payer mix. Payer mix, to me, is always a function of the local market, coupled with, you know, the mission-driven aspect of that organization. And I'll just name one here in Dallas, which is Parkland Hospital, the county hospital. Its payer mix is going to look probably very different than some of the hospitals that may be a few miles up the road, simply because it's the county hospital, and that's where the indigent folks who don't have health insurance go, and so it's a very different payer mix. So, I think when we talk about payer mix, it's not just organizational features. It's also the local market, because some of the nonprofits that are in some very affluent neighborhoods in Dallas-Fort Worth, I don't think they have a problem with payer mix. Maybe they do, and I don't know it. *laughter*

DAVE GANS: I doubt it. *laughter*

TIM SMTH: That's a local market thing. You know, the revenue cycle of this, to me, it's a fascinating question. I often hear this with health systems, and there's one client I had over the years that was always “Yeah, our centralized billing office just has a terrible revenue cycle, they don't collect.” When I've talked to experienced practice managers about that, what they've said is, oftentimes, that you get diseconomies of scale when you centralize billing; you take it out of the office, where there's a lot of firsthand knowledge. The other thing that you don't get is, maybe, is practice discipline of, “Hey, you can't see the doctor again, for your followup visit, until you pay your prior bill.” Or, you know, they try to get people to pay when they check in. You know, the perplexing thing for me with health systems is when they point to poorly performing operations, you know, my reaction is, well, why don't y'all fix it? I don’t get it. If your CBO doesn't work, then outsource it. Get somebody that makes it work. I mean, this is the same thing I hear…kind of the corollary to this is, well, our overhead’s a lot higher. And it is true, when you get into large organizations, they often have a compliance department, they have IT managers, etc. You start to layer in lots of resources that a smaller practice doesn’t have. But if you start looking at larger practices, they often have the same level of scale and have all of these higher costs as well. But I look at a lot of health systems, and I hear them talk about “Our costs are too high.” And I think to myself, well, why don't you fix it? Why don't you outsource the management to somebody who can keep it down? Again, if your comparison is a small, two-doctor practice that doesn't have a compliance department, or a revenue cycle department, an HR department, an IT department, etc. Well, that's one thing. But if you're looking at a group that you acquired that had 50 doctors in it, and you ran up their costs, you may want to take a step back and say, what are we doing where we ran up the costs? And I know this is one of those contentious points, often, between the physician enterprise and the overall health system or the hospital side is, what are you doing pushing all those costs out to the practice? And I know that gets into all these intercompany accounting issues, but I kind of look at that and say, why don't you fix it? Or, do some good cost accounting and figure out what you should be pushing out.

DAVE GANS: I agree 100%. In fact, we've talked all around the issue, but I'll come back to it. In my observations, it has been the number one issue why practices that are part of a health system have lower revenue, even if you look at the productivity being relatively similar, it has to do with the concept called provider-based billing. You know, this is the hospital, outpatient prospective payment system that allows the hospital to charge a separate facility fee for a service. And of course, on the physician fee schedule, what we see is that the commensurate fee schedule is reduced for the physicians.

So, the end result is that if you're part of that hospital outpatient prospective payment system, that a physician billing the same service bills at a different portion of the physician fee schedule, which is about 35% less than what it would be as if they were billing under the full fee schedule amount. Now, for the same service, we see this even looking on physician productivity metrics. For example, hospital-based practices all will, typically, show relatively similar total RVUs for physicians. However, they’re hospital-based systems, so very similar physician work components, because those are the same. But the total RVU is less because of this reduction in the cost expense portion. So, can you give some of your insights into what is occurring in this environment, where you’re billing less for the same service?

TIM SMITH: Sure, and I think just to clarify, here you're talking about the idea that it’s the entire clinic, not just the ancillaries. Earlier, we talked about the ancillaries being converted to HOPD. Here, you're talking about the entire clinic being converted HOPD. Is that correct, Dave?

DAVE GANS: That is correct.

TIM SMITH: That introduces yet another component of how to look at the earnings of the practice. Now in theory, all of the costs of the practice, outside of physician comp, and maybe some related physician benefits costs, maybe PLI, for example, might be borne over in the actual physician practice entity that's billing. But all of the practice overhead should be in that HOPD, the hospital outpatient department. But you're right, when you do comparative analysis, and you're looking at the total revenue, or even the professional collections of those practices, where part of it or nearly all of it has been converted to HOPD, the revenues look very different, because those revenues are moved into the hospital side rather than the physician practice side. And so yeah, that's another complicating factor. When you look at, for example, survey data, and you're trying to make sense of different revenue levels, because that may have nothing to do with differences in pure productivity or payer mix or reimbursement rates or collection rates, it may just have to do with the fact that a chunk of the revenue just is over on the hospital side. As you're saying, Dave, there's some complex issues here because organizationally, as an owner-operator, health systems take practices and do things with them that the other owner-operators don't do; private equity doesn't do that. Nobody can do this but a health system, right? Because nobody can bill HOPD unless you're a hospital. So, you know, the payers can't do this at the United Healthcare practices, private equity can't do this, and physician-owned practices can't do this. So, it really presents a challenge. I like to call it the Humpty Dumpty problem, because, in a sense, health systems push Humpty Dumpty off a wall, and breaks it up into pieces, and how do you put it back? *laughter* Maybe that's the wrong analogy. But you know, you’ve got all these pieces and parts, and what do you do? Or it's LEGO bricks, maybe that’s better. *laughter*

DAVE GANS: And actually, maybe this leads into another aspect, and that is, what advice would you give to a practice executive in a hospital-based practice, who, oftentimes, when they're at the corporate meetings, they get beaten up over their practice losses by other aspects, other executives in the health system? So, what advice would you give that practice leader on how can they best respond when these practice losses are brought up? Because they're oftentimes feeling that they're being picked on.

TIM SMITH: What I think is that health systems need to go through the following sort of process with their losses. And I think, given with what CMS has now said, that ongoing losses do present concern about program integrity issues, meaning Stark compliance, that health systems need to go through a very systematic and in-depth process to understand their losses. I'm going to give you a nice little rhyming scheme here: Identify, quantify, and justify.

I think you've got to go through and identify why you're losing money. Let's go through the list of things that can possibly go wrong. By the way, one thing we didn't talk about, Dave, was how many times with services like hospital call coverage, hospital medical directorships, hospital co-management, the compensation for those services is paid out to the doctors in their compensation through the physician practice. But there's no intercompany credit coming from the hospital side as a kind of revenue credit to the practice, to account for the value of those services that the physicians provide to the hospital as a hospital. Remember, the things I just mentioned, those are hospital operations. And if those doctors are in private practice, there would be dollars coming out of the hospital going into the physician practice. Well, your accounting needs to do the same thing; it's going to be intercompany accounting. But I think the first thing for a health system to do is to go through and let's look at all of these possible factors. Let's identify the ones that we think apply to us. Let's go through and quantify what we think applies to us, and then let's go through a systematic process, saying, can we justify each one of these loss contributors, based upon does it meet community need, does it facilitate medical need, and things like this, in the community? Are these things that we can justify? And I think that needs to be done on a recurring basis; maybe not every year, maybe biannually. But I do know that this is an area of compliance for which health systems need to exercise due diligence, in kind of a thoughtful, systematic process. When I talk to people from health systems about this, what I tend to hear is a lot of high-level discussion of, in theory, here's why we lose money, or in concept, or, “Well, we're mission driven, therefore, we lose money.” But I don't hear anybody saying, “Oh, yeah, we've done an in-depth analysis, and here's why we're losing, and we believe we can justify the losses for these reasons.” I think the latter is what's going to…it seems to me, from what I've read about whistleblower cases, if a health system has done its homework and really thought through these losses, that's going to prevent, I think, a lot of whistleblower cases emerging. If nothing else, the doctors in your organization and the people working in your organization will understand, hey, we lose money, but it's for these reasons, which we think are valid under the Stark Law. And so, I would encourage every health system to start to work on this area.

DAVE GANS: Excellent comments. You know, Tim, there's so much more we could talk about. And I know with your schedule, that your time is limited. Anything you'd like to add to today's discussion, to summarize and bring it and to let our listeners have a take home?

TIM SMITH: I think now, it's that practice losses are back on the map. It's a fair market value and a commercial reasonableness issue. You don't have to make money, says CMS, for commercial reasonableness. But you need to be looking at this. It needs to be part of your compliance program, and really, it should be part of your business intelligence program. You should be looking at your operations, understanding why you're committing the resources that you are, and whether you're being good stewards of the physician enterprise. And I think a thoughtful analysis process is what you do to make sure you're being good stewards of the resources for the overall health system.

DAVE GANS: Excellent comments. Tim, thank you so much for your time. I know our listeners will find this discussion most interesting, and I'm looking forward to your session that you're going to give at the Medical Practice Excellence Pathways Conference. I think you've got a lot of extremely interesting and insightful information to pass on, and I'm looking forward to hearing you at the conference. Thank you very much.

TIM SMITH: Thank you, Dave.