INDUSTRY INSIGHTS | FALL 2011 EFFECT

Fair Market Value and Regulatory Considerations for the ACO Model

by Kevin Cope

One of the key components of health reform teams up a network of providers (i.e., hospitals, physicians, and others) to offer a continuum of patient care. The idea is that by working together, instead of in silos, they will provide better quality care and share in both the costs and savings that come with collaboration. This model is called an accountable care organization (ACO).

Under the Patient Protection and Affordable Care Act (PPACA), an ACO “promotes accountability for a patient population and coordinates items and services under [Medicare] parts A and B, and encourages investment in infrastructure and redesigned care processes for high-quality and efficient service delivery.” ACOs that meet these quality and performance standards will be eligible to receive payments for their efforts.

Ideally, strong incentives will encourage providers to coordinate care and streamline procedures—ACOs that meet quality targets would keep a portion of the savings, while those that don’t could lose money. But as the government rolls out its guidelines for ACOs, there is increasing debate in the industry as to whether they can be implemented effectively and how much additional savings and income can possibly be achieved. Some major health care systems have balked at the concept of ACOs, citing burdensome data collection requirements, large start-up costs, uncertain savings, possible losses, and troublesome governance mandates. Overall, it is yet to be determined whether the costs of implementation and administration will exceed the potential economic reward for ACO owners.

Some concerns are emerging about the structure of these organizations. An ACO could be a joint venture among a group or groups of independent physicians and a hospital. Depending on the form and configuration of the new organization, providers and participants may encounter issues determining the fair market value (FMV) of transactions and applying relevant regulatory requirements.

Application of existing laws

Under the proposed ACO rules (March 2011), Medicare would pay individual providers and suppliers for specific items and services like it currently does under the original Medicare payment systems. However, the Centers for Medicare & Medicaid Services (CMS) would develop a benchmark for each ACO to measure performance and assess whether it qualifies to receive shared savings or will be held accountable for losses.

One of the key, yet missing, components of the ACO model is the method for distributing any potential shared savings or income among participants. CMS has provided little guidance on how the money can or should be split, or the applicability of existing constraints like the Stark and anti-kickback laws.

The “Stark law” prohibits physicians from referring Medicare and Medicaid patients for certain health services to entities with which they have a financial relationship, unless there is a safe harbor (e.g., an in-office exception). The “anti-kickback law” prohibits a health care provider from giving something of value to another provider for less than or more than fair market value, in order to induce referrals of Medicare or Medicaid patients.

In the absence of clear regulatory guidance, the ACO and its advisors must develop a model that compensates the ACO’s participants for their investment and provides fair market value for their medical services. But it must also conform to the Stark law, anti-kickback statute, and anti-inurement provisions of the Internal Revenue Code.

Potential fair market value issues

There are a few FMV concerns that might apply to the formation of ACOs, including provider compensation, valuing assets contributed, return on investment made by ACO members, and the distribution of cost savings (income) to member owners.

Provider compensation

ACO providers will expect compensation that reflects their contribution to professional services rendered, quality of care, and cost savings. The typical physician compensation models may not work in an ACO atmosphere that emphasizes medical care quality versus procedure quantity. Consequently, compensation models might migrate to payments based on different performance measures (e.g., expense reduction or hospital readmission rates) versus the current focus on productivity measures (e.g., relative value units or percentage of collections). These compensation models must be at fair market value and will need to comply with the Stark and anti-kickback laws.

Capital investment and asset contribution

Participants, such as hospitals or physicians, that invest in the ACO by supplying start-up capital and other assets, will expect a reasonable return on their contribution. But the variety of assets will have different costs and risk profiles, and consequently different values. Examples could include cash, working capital, intangible assets (e.g., a trained and assembled workforce or patient base), or an income-producing ancillary, such as diagnostic testing or a medical lab operation. The value of the asset contribution will be important in determining how any income or savings is allocated among the ACO participants.

Determining the value of cash contributions and working capital is relatively straightforward and is typically at either cost or net realizable value. The FMV of equipment can be appraised at cost or market using a standard that assumes the item is “in place” or “in use.” Any income-producing ancillary business would be appraised at its fair market value using an income, market, or cost approach.

A bigger challenge is putting a value on the intangible assets, such as a workforce or patient base, because they are usually riskier and therefore would require a higher rate of return. Valuation methods for intangible assets include replication cost and royalty analyses.

Shared savings and income distribution

The risk-adjusted calculated value of each participant’s contribution should be the basis for determining its percentage of the shared savings or the income available to each party. It will also help in determining if the ACO’s earnings stream is sufficient to provide an appropriate risk-adjusted rate of return on their respective contributions to the organization.

An ACO’s economics make sense if the organization can provide an adequate return on investment while providing cost savings to the overall health care system and improving the quality of care to patients. Properly determining provider compensation models, valuing asset contributions and income distribution policies, and complying with regulatory requirements will be important considerations in forming successful ACOs.