In “Valuing Healthcare Management Services Agreements,” PYA Principal Tynan Olechny discussed the types of management services found in the healthcare marketplace. Her NACVA webinar presentation addressed the valuation of these services with a focus on how the appraiser can analyze the key economics of management services agreements. She also examined how the commercial reasonableness of these arrangements can be evaluated and assessed as part of the valuation process.

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Agenda
2 Management Services Defined
3 Critical Factors in Valuing Management Services
4 Valuation Approaches
Agenda
1 Introduction
2
2 Regulatory Considerations3
4
5
4 Case Studies6

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Introduction
• Have been in existence in healthcare for decades and historically
focused on administrative and/or operational tasks
• Provide hospitals, ambulatory surgery centers (ASCs) and physician
practices with operational and functional services
• Common situations where healthcare provider might seek third-party
entity for management services
– Provider determines that outsourcing certain management functions will
result in optimization of its operations
– As part of an acquisition or joint venture
– One provider seeks to affiliate with another by integrating some level of
operations or one party provides expertise and infrastructure to the other

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• Management services or ―purchased services‖ are geared towards
strengthening business aspects of an operation
– Expertise, cost-efficiency, and economies of scale in business services
• Outsourcing of medical and/or administrative services
Clinical Operational Needs Non-clinical Operational Needs
Medical Directorship Contract Negotiations
Clinical Staff Legal and Financial Services
Clinical Management Risk Management
Billing
Human Resources Support
Operations Management
Management Services Defined

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• Between ―like‖ provider entities
– Hospital providing management services to another hospital
• Between different types of providers
– Physician practice and a hospital/health system
• Between providers and third parties
– ASC and third-party manager
Types of Transactions

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• Refer to instances whereby hospital and physicians collaboratively
manage and operate a particular hospital service line or
program, such as orthopedics, cardiology, or oncology
– Shared vision
– Formal alignment in patient care delivery
– Improved program outcomes
– Enhanced association between hospitals and physicians
– Operational excellence
– Effective decision-making structure
New Trend: Co-Management and Service
Line Management Arrangements

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• Accounting & Financial
Management
– Budget development
– Internal financial statements
– Billing services
– Managed care contracting
– Malpractice premium negotiation
– Oversight and monitoring
• Operations
– Day-to-day oversight and
administration
– Staffing and scheduling
– Equipment and supply
procurement
– Policies & procedures
– Regulatory compliance
– Assistance with credentialing
Examples of Management Services

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• Human Resources
– Review of staffing levels
– Recruitment and retention
– Training and orientation
– Appointment and evaluation of
clinical and non-clinical staff
• Leadership
– Medical director services
– Medical staff activity participation
– Management and/or advisory
committee participation
• Strategic Planning
– Development of strategic plan
– New program development
– Participation in strategic planning
process
• Other
– Quality and process improvement
– Patient and community outreach
– Assistance with accreditation
Examples of Management Services

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Traditionally
• Fixed fee or cost of
providing services plus
profit factor
• Percentage of net patient
revenue (i.e., billing)
• Mark-up percentage on
cost (i.e., employee
leasing)
Today
Compensation for
Management Services
• Fixed fee based on certain
pre-defined services plus
• ―At risk‖ component based
on achievement of defined
quality outcomes and
metrics (i.e., reducing
infection rates, attaining
patient satisfaction, etc.)
“Traditional” “Modern”

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Regulatory Considerations
You‘re not paranoid -- they really are after you.

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Regulatory Considerations
• Federal False Claims Act
• Federal Anti-kickback Laws (fraud and abuse laws & regs)
• Stark Laws (physician self-referral laws & regs)
• IRS Private Inurement Regulations (affecting tax-exempt organizations)
• State Anti-kickback and Self-referral Laws
• Provider-based Status Rules

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• ―The price at which the property or service would change hands between
a willing buyer and a willing seller, neither being under a compulsion to
buy or sell and both having reasonable knowledge of the relevant facts.‖
(Estate Tax Reg. 20.2031.1-1(b); Revenue Ruling 59-60, 1959-1, C.B. 237)
• This definition is consistent with the Stark Law definitions of fair market
value and general market value, which are defined as follows:
– Fair Market Value: the value in arm‘s-length transactions, consistent with the general market
value.
– General Market Value: 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. (Federal Register / Vol. 69, No. 59 / Friday, March 26, 2004 / Rules
and Regulations)
Fair Market Value Defined

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Commercial Reasonableness Definition
• The Centers for Medicare & Medicaid Services (―CMS‖) formerly
interpreted the requirement of ‗commercial reasonableness‘ to
designate an arrangement appearing to be ―a sensible, prudent
business agreement, from the perspective of the particular parties
involved, even in the absence of any potential referrals.‖ (63 Fed. Reg.
1700 - Jan. 9, 1998)
• CMS further clarified its intent in subsequent Stark Law
commentary which states that ―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 type and size and a reasonable
physician (or family member or group practice) of similar scope
and specialty, even if there were no potential designated health
services (―DHS‖) referrals.‖ (69 Fed. Reg. 16093 - March 26, 2004)

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Fair Market
Value___________________________________________________________________
Cents___________________________________________________________________
Scope: Range of Dollars
Only
Key Question: “How Much”?
Commercial
Reasonableness___________________________________________________________________
Sense___________________________________________________________________
Scope: Overall Arrangement
Key Question: “Why”?
Compliance Issues Regarding
Financial Relationships
Two Components

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Presence of
Legal
Agreement
FMV
Assessment
of Services &
Fees
Define Scope
of Services
and Areas of
Need
Understand
Legal
Structure
• Administrative and operational services
• Clinical responsibilities
• Incorporation of quality incentives
• Contracts between:
Physician group and
hospital
Hospital and
management
company formed to
execute management
services
ASC and ASC
management
company
• Duties and responsibilities
• Provision of terms
• Termination of agreement
• Compensation
• Appraiser with experience
in healthcare transactions
• Consideration of other
arrangements (i.e., call
coverage, medical
directorship, physician
lease, or leaseback
agreements)
• Commercial
reasonableness
Critical Factors in Valuing
Management Services

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• Management arrangements can be valued based on the
following approaches:
• Cost Approach: Value indication as if the services were performed
internally; involves a calculation of the cost to replace or replicate
• Market Approach: Value as indicated under the principles of a free
market, such that supply and demand forces will determine prices of
business assets; market data is analyzed to determine what is actually
being paid in the marketplace for comparable services
• Income Approach: Value indication determined by the accrued economic
benefits of an asset
• Build vs. Buy: Would it be more cost-effective to perform
management services internally?
• Yes, Build: Cost Approach
• No, Buy: Market Approach
Valuation Approaches

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• Gain an understanding of the scope of services
Each agreement has its own unique set of considerations and services
If the agreement is vague, appraiser should interview the hospital‘s legal
counsel
Wording of agreements should be taken into careful consideration
―Assist with billing and collection functions‖ vs. ―perform billing and
collections‖
• Determine appropriate level of staffing and resources
Nature of company being managed differs greatly (i.e., physician practice vs.
hospital outpatient department)
Historical and projected revenues will impact the level of management
services required
Level of complexity, diversity and comprehensiveness of services will impact
resources required
Cost Approach Considerations

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• Determine costs of providing services
For required staffing, various salary surveys should be analyzed to determine
appropriate compensation amounts
Differentiate between clinical and administrative duties
Reasonable markups to reflect the risk that the management company is
assuming by employing required staff should be included
Agreements including other services may require additional resources
If facility space is part of the arrangement, the determination of
appropriate markups or fair market value rent should be conducted by a
qualified real estate appraiser
Cost Approach Considerations
(continued)

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• Identify market comparable data with similar components or risk
profiles as the subject arrangement
ASCs
• Management arrangements are prevalent
• Is the provision of clinical staff included?
• Is the ASC management company a minority owner in the ASC?
Publicly traded companies providing management services
• Analyze data and make comparability adjustments
• Weigh importance of tasks being evaluated against market comps
• Compare risk/responsibility of management company to market comps
• Consider revenue size of market comps to determine whether
management fee as a percentage of revenue is appropriate for subject
Market Approach Considerations

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• Determine the value of the economic benefits that would accrue to either
side of the management services arrangement
– To analyze the seller‘s benefits, consider the profit level of the management
company given the calculated management fee and compare with market-
based rates; the amount of the management fee should appropriately reflect
the level of risk that is being assumed by the management company
– To analyze the buyer‘s benefits, determine the value of the benefits that would
accrue to the managed organization from the services provided by the
manager (i.e., isolate the financial impact to those results achieved by
management company‘s efforts) or evaluate the total earnings, margins, and
returns of the organization given its purchase of the management services
– Analyses have practical limitations
Income Approach Considerations

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Necessity of
Specialized
Expertise
Oversight and
Monitoring
Legitimacy of the
Business Purpose
Appropriateness of
Management
Services
• Does the proposed arrangement
represent a reasonable necessity
for the operation of the managed
entity?
• Is the management agreement
necessary to further a legitimate
business purpose of the managed
entity?
• Are the particular duties of
the management company
clearly defined?
• Are the management
services a necessary
addition to the managed
entity‘s current managerial
or administrative staff?
• Does the management agreement
require the services of physicians or
other specialized staff?
• If so, does the management
company possess the requisite
expertise and experience to perform
the management services?
• Is there a written agreement that
clearly defines the terms of the
agreement?
• Does the managed entity engage
in routine monitoring efforts to
ensure that the required services
are actually performed?
Commercial Reasonableness

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Project: Assessment of FMV compensation for a potential management
services agreement to provide clinic start-up services, administrative and
management services, personnel and human resources, and billing
services.
• Scope of services: Administrative services
• Type of transaction: Between management company and physician
practices
• Presence of legal agreement: 1-year renewable agreement
• FMV assessment of fees: Cost and market approaches
• Compensation: Total annual payment
Case Study #1

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Project: Assessment of FMV compensation for the co-management of
cardiology services between a hospital and physician practice
• Scope of services: Clinical and administrative services
• Type of transaction: Between hospital and physician practice
• Presence of legal agreement: 3 years
• FMV assessment of fees: Cost and market approaches
• Compensation: Fixed fee for provision of defined administrative and
medical directorship services with ―at risk‖ payment for achievement
of identifiable quality metrics
Case Study #2

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Contact Information
Tynan P. Olechny, MBA/MPH, CVA
Principal, PYA
404-266-9876
tolechny@pyapc.com