Understanding Mergers and Acquisition in the Healthcare Marketplace May 2011

Overview of Business Activity –The healthcare market is consolidating –We will focus on the northeast market – NJ/NY/PA –Consolidation is mostly in the following sectors: Hospitals Surgery Centers Physician Practices –Few negotiations have been finalized to-date –The average time estimate for the negotiation process is 15 to 18 months – Some in excess of 3 years –Friendly PC, Leased Provider, Employee or Hybrid entity choices in these deals 2 Understanding the Healthcare M&A Marketplace

Case Study #1 –Situation Practice experiences an initial decline in cash flow Practice has started to see more overpayment audits Practice has a sound business model Practice has an effective management team Local health system announces a business strategy to merge with physician practices Practice requests to be considered for merger Negotiations start with both parties 3 Understanding the Healthcare M&A Marketplace

Case Study #1 –Result of practice assessment Net collection opportunity to increase cash flow annually Significant overcoding in practice Numerous business process recommendations Health system reimbursement higher than practice Staffing levels in line with surveys Overhead percentage slightly higher than surveys Good payer mix Respected brand name in the community 4 Understanding the Healthcare M&A Marketplace

Case Study #1 –Outcome of Negotiations to-date Negotiations are still active – 12 months to-date Talks progressed from merger to acquisition Effort to increase physician compensation - wRVU Entity discussion towards a friendly PC model Billing under the tax ID of the health system Strategic fit for health system/practice Cultural fit for health system/practice Value to business model Value to branding 5 Understanding the Healthcare M&A Marketplace

Legal Issues Brief Background of Important Laws –Stark and Anti-Kickback laws prohibit payments in exchange for referrals of services paid for by Medicare/Medicaid –Anti-Kickback Statute (AKS): Intent-based statute –Bona-fide reasons for transaction (e.g., integration) Criminal and civil penalties

Legal Issues cont’d –Stark law Strict liability Civil penalties Compensation cannot be based on “volume/value of referrals” of designated health services –Exception: personally performed services (e.g., wRVU) How to structure compensation? –“Eat what you kill” –Compensation pools

Legal Issues cont’d –FMV/commercially reasonable payments –Important: independent valuation report from reputable source –Recent case law (whistleblower actions): U.S. ex. rel. Singh v. Bradford Regional Medical Center –Hospital paid group fixed fee for equipment sublease and non-compete –FMV fee should not take into account anticipated referrals in certain cases. –Court found fixed fee took into account future referrals

Legal Issues cont’d –U.S. ex. rel. Drakeford v. Tuomey Hospital employed physicians part-time for its outpatient surgery center Physicians paid 131% of their collections (national data cites 49%-63%) Physicians exclusive to Tuomey Court found physicians’ compensation inflated to take into account their referrals because each surgery generated a PC and a TC.

Legal Issues cont’d Case Study #1: –Potentially large upfront payment to physicians –Loss of control/decision-making –Broad non-competes –Harder to unwind –Public disclosure of information if tax-exempt Captive PC

Case Study #1 –Insurance Summary Property- Insurable interest and contract covenants Stark-Fines, Penalties, Defense Billing and Coding-Fines and penalties for overcoding General Liability will not cover dishonest acts. Innocent parties may be covered in the D&O policy Medical Malpractice-Form of risk transfer and legacy issues Management Protection Coverage Who owns the policies? 11 Understanding the Healthcare M&A Marketplace

Case Study #1 –Insurance Summary Employment Practices-Declining cash flow Workers Compensation-Combinable entities Directors and Officers-Run Off Coverage Fiduciary Liability-Separate entity for employees 12 Understanding the Healthcare M&A Marketplace

Case Study #1 –Insurance Summary Directors and Officers-Unsound business model Workers Compensation-Leasing situation Crime Insurance-Adequate staffing vs. low productivity 13 Understanding the Healthcare M&A Marketplace

Case Study #2 –Situation Practice experiences a consistent decline in cash flow Practice has started to experience overpayment audits Practice has a sound business model Practice has a respected brand name Practice does not have an effective management team Founding partner is nearing retirement Local health system has been talking to the practice Practice requests to be considered for merger Negotiations start with both parties 14 Understanding the Healthcare M&A Marketplace

Case Study #2 –Result of practice assessment Practice productivity lower than survey median Collections per physician are at the survey median Health system reimbursement higher than practice Numerous business process recommendations Staffing levels in line with surveys Overhead percentage in line with surveys Good payer mix Respected brand name in the community 15 Understanding the Healthcare M&A Marketplace

Case Study #2 –Outcome of Negotiations to-date Negotiations are on hold Talks progressed from merger to acquisition Problem with valuation of practice Effort to increase physician compensation - wRVU Entity discussion towards a hybrid model –Friendly PC model for physicians –Separate entity for employees Billing under the tax ID of the health system Strategic fit for health system/practice Cultural fit for health system/practice Value to business model Value to branding 16 Understanding the Healthcare M&A Marketplace

Legal issues Case Study #2: –AKS Bona fide reasons for transaction –Potential areas of concern: Deferred compensation Retained liabilities Preserving group unity (e.g., effect of termination of one or more physicians)

Case Study #2 –Insurance Summary Property- Insurable interest and contract covenants Billing and Coding-Fines and penalties for overcoding Medical Malpractice-Form of risk transfer and legacy issues Management Protection Coverage Who owns the policies? 18 Understanding the Healthcare M&A Marketplace

Case Study #2 –Insurance Summary Employment Practices-Declining cash flow, may have to reorganize Workers Compensation-Combinable entities, effect on reporting of payouts Directors and Officers-Run Off Coverage Fiduciary Liability-Separate entity for employees 19 Understanding the Healthcare M&A Marketplace

Case Study #2 –Insurance Summary Directors and Officers-Unsound business model Workers Compensation-Leasing situation Crime Insurance-Adequate staffing vs. low productivity 20 Understanding the Healthcare M&A Marketplace

Case Study #3 –Situation Practice experiences a significant decline in cash flow in the last 12 to 15 months Practice has started to experience overpayment audits Practice does not have a sound business model Practice has a respected brand name Practice does not have an effective management team Local health system has been talking to the practice for an extended period of time Practice requests to be considered for merger Negotiations start with both parties 21 Understanding the Healthcare M&A Marketplace

Case Study #3 –Result of practice assessment Practice productivity lower than survey median Collections per physician are at the survey median Numerous business process recommendations Health system reimbursement higher than practice Staffing levels in line with surveys Overhead percentage in line with surveys Good payer mix Respected brand name in the community 22 Understanding the Healthcare M&A Marketplace

Case Study #3 –Outcome of Negotiations to-date Negotiations are continuing to-date Talks progressed to a leased provider arrangement –Health system is leasing providers –No acquisition of practice by the health system Effort to increase physician compensation - wRVU Billing under the tax ID of the health system Strategic fit for health system/practice Cultural fit for health system/practice Value to business model Value to branding 23 Understanding the Healthcare M&A Marketplace

Legal Issues Case Study #3: –AKS and Stark: Bona fide reasons: is there real integration? Potentially, fewer issues under Stark If non-compete included, Bradford suggests: –Non-competes in leases may be more problematic –Non-competes may be viewed as a requirement to refer –Easy to unwind

Case Study #3 –Insurance Summary Property- Insurable interest and contract covenants Billing and Coding-Fines and penalties for overcoding Medical Malpractice-Form of risk transfer and legacy issues Management Protection Coverage Who owns the policies? 25 Understanding the Healthcare M&A Marketplace

Case Study #3 –Insurance Summary Employment Practices-Declining cash flow Workers Compensation-Combinable entities Directors and Officers-Run Off Coverage Fiduciary Liability-Separate entity for employees 26 Understanding the Healthcare M&A Marketplace

Case Study #3 –Insurance Summary Directors and Officers-Unsound business model Workers Compensation-Leasing situation Crime Insurance-Adequate staffing vs. low productivity EPLI – Non-competes D&O – “Insured vs. Insured” 27 Understanding the Healthcare M&A Marketplace

Legal Issues Impact of Health Reform on M&A deals: –Patient Protection & Affordable Care Act of 2010 (“PPACA”) –Value-based purchasing: Transforms Medicare from “passive” purchaser to “active” purchaser How? –Modifies Part A and Part B payments for achieving/reporting quality standards

Legal Issues Accountable Care Organizations (“ACOs”) –Definition: Group of providers with joint responsibility for quality and cost of care provided to assigned Medicare beneficiaries –Proposed Regulations Issued March 31, 2011 by CMS, as well as regulatory guidance from OIG, CMS, FTS, DOJ and IRS.

Legal Issues cont’d Significant Details Include: –ACO must be a legal entity under State law (e.g., corporation, LLC) –ACO must have TIN but need not be enrolled in Medicare –ACO participants: physicians, physician practices, networks of physician practices, hospitals employing physicians, joint ventures of physicians and hospitals and others

Significant Details cont’d: –ACO must have “shared governance” (i.e., a governing board) At least 1 Medicare beneficiary (without conflict of interest) Optional: community stakeholder ACO participants must have at least 75% control of board –Outsiders (non-clinicians) can have up to 25% control of board

Significant Details cont’d: –ACOs must have: a manager who reports to the board full-time medical director –senior executive of ACO –board-certified, licensed physician “meaningful commitment” by participants: –Financial –Human (time and effort)

Legal Issues Significant Details cont’d: –Assignment of Beneficiaries: At least 5,000 Medicare beneficiaries Enough PCPs to service 5,000 patients By utilization of a “plurality” (not majority) of services from PCP Retrospective

Significant Details cont’d: –Important: each PCP is exclusive to one ACO –Specialists can be in multiple ACOs –ACO can remove, but not add, ACO participants during 3 year term of agreement –ACO must come up with a plan of distribution of savings

Legal Issues Significant Details cont’d: –2 Models and 2 Tracks for Shared Savings: Both involve sharing of losses at some point –To get savings, ACO must both: Report and meet quality measures (65 within 5 domains); and Achieve cost savings beyond a minimum rate –Disclosure of information to patients: Patients can seek care from non-ACO providers –ACO must have infrastructure to gather and report data (e.g., IT)

PPACA provisions: More coordinated patient care Focus on quality and cost savings Substantial upfront cost e.g., formation of ACOs (IT and other infrastructure, training etc.) Impact: higher degree of integration in industry –For offensive or defensive reasons (e.g., PCPs)

Contact Information Michael McLafferty CPA, MBA, CHFP, FACMPE Partner, Healthcare Services Group EisnerAmper, LLP Understanding the Healthcare M&A Marketplace