By Timothy Smith, CPA, ABV
Careful readers of the new Stark regulations will notice CMS made a series of critical statements regarding losses in health system physician practices. On the one hand, CMS finalized the definition of commercially reasonable (“CR”) to exclude a requirement that an arrangement results in a profit for one or more of the parties.[1] On the other hand, CMS stated in its commentary that the profitability of an arrangement is not completely irrelevant to the determination of CR.[2]
More importantly, CMS expressed concern over ongoing practice losses as a question of fair market value. The Agency devoted an entire section discussing the question of practice losses as part of its regulatory commentary about FMV. “We agree that, in some circumstances, an entity’s compensation of a physician at an ongoing loss may present program integrity concerns,” CMS stated as its first statement on the issue of losses and FMV.[3]
The key takeaway for health systems seeking to ensure FMV and CR compliance under the new regulations is that practice losses is an area to be addressed as part of any compliance program. Unlike the litigation precedent for examining losses on purely CR grounds during the 2010s, Stark compliance for the 2020s will entail both FMV and CR assessments of the losses. The new requirement will undoubtedly present health systems with complex issues because the causes of practice losses are varied and nuanced. There is not a simple answer to the question of why systems typically lose money on their practices. Moreover, the analysis of why a health-system practice loses money involves fact-specific questions related to the individual practice.
Yet, there is one area health systems can immediately review in moving to address practice losses: intercompany transactions for services between the physician enterprise and the larger health system. Intercompany accounting practices may overstate practice costs, and thereby contribute to reported practice losses.
Two types of intercompany transactions frequently inflate practice losses, while understating hospital or corporate expenses. These cost-shifting areas include professional services that employed physicians provide to system hospitals and cost allocations for shared corporate services.
Employed physicians in health system practices commonly provide various professional services to affiliated hospitals within the system. Examples of such services include medical directorships, call coverage, and clinical co-management services. Shifting of hospital costs to physician practices occurs when the practices do not receive an intercompany payment or credit for the value of services that benefit the hospitals.
We can trace the cost-shifting by following the money trail. Generally, the physician compensation for these professional services is paid through the employment agreement, and the compensation cost is recorded on the books of the practice. Yet, many health systems do not record an intercompany transaction for the value of these services between the hospitals and practices. Since the services directly benefit the hospital or one of its departments, the cost of these services should be recorded on the hospital’s books, not the practice’s.
The net result of this omission is to shift hospital operational costs to the physician practice. The practice bears the physician cost for the services, while the hospital shows no physician expense, thereby distorting the real economics of both the physician practice and the hospital. This accounting distortion may result in a loss for the practice or contribute to higher losses when combined with other factors.
We can contrast how these services would be handled if the physicians providing the services were independent. In that situation, the hospital would pay for the services based on FMV. The cost of the services would be reported in the hospital’s books, fairly stating the cost of resources used in providing patient care. The payments to the independent physicians would create practice revenues, offsetting physician compensation and other related costs on the books of the practice.
To avoid “fake” or mere “paper” practice losses, health systems should treat their affiliated physicians as if they were independently practicing. The FMV of the services should be credited to the affiliated physician entities as intercompany revenue, while an expense hits the books of the hospitals. This approach is consistent with CMS’ “buyer-neutral” standard for FMV and general market value under the new Stark regulations. Under this framework, the value of physician services should be the same, regardless of whether the buyer of services is an entity owned by physicians, private equity, or a hospital.[4]
The second area for cost-shifting involves corporate shared services. Many health systems provide administrative and support services to their physician practices through corporate functions or departments. The costs of these services are usually charged to the practice on an allocation basis. Two cost-related issues can arise when physician practices utilize such services.
First, some of the costs for these shared services may relate solely to hospital operations and not the physician enterprise. In addition, cost allocation formulas may not reflect actual usage of the services by physician practices within the organization. In these circumstances, practices may be overcharged for corporate services.
Second, physician practices may be allocated costs for corporate services that they could readily obtain at lower rates from third parties. Yet, the health system chooses to provide these services on an in-house basis for reasons that benefit the larger organization.
Like physician services provided to hospitals, the solution for these types of cost allocations is to charge them at FMV rates. By using FMV, the negative financial impact of health system decisions will not contribute to reported practice losses.
Now, many health systems may wonder about the benefit of such intercompany accounting practices, if the physician enterprise rolls-up into the consolidated financial statements for the health system. Under the new Stark regulations, however, there is a clear benefit for compliance. Since losses will be scrutinized for potential FMV and CR issues, larger losses will naturally lead to more questions and potential risks relative to compliance. Health systems can eliminate losses that do not relate to the economics of health system practices but only reflect organizational accounting issues. In doing so, health systems can eliminate one layer of “noise” related to the issue of practice losses.
[1] 85 F.R. 77531.
[2] 85 F.R. 77534.
[3] 85 F.R. 77556.
[4] 85 F.R. 77555.
