Imaging and the Anti-Markup Rule

November 18th, 2007 | Uncategorized

CMS adopted the changes it proposed this past summer in the 2008 MPFS Proposed Rule with respect to the so-called anti-markup provision.  The effect of these new administrative rules which occur outside the Stark regulations is to effectively make the “in office ancillary services exception” (IOASE) practically moot.  The IOASE, issued in Phase 2 of the Stark regs after complaints from various physician groups, allowed physicians to get around the general prohibition against referral to a DHS entity through sharing equipment located in a building in which they provided some non-DHS services.  Structures such as block leases were commonly used.  It appears that the interpretation of the requirement that DHS equipment be located in the “same space” means the same office suite.  Office suite likely means commonly connected contiguous space.  Thus, even a DHS facility on the same floor as the physicians’ non-DHS space would not qualify if there are third parties located in intervening space or even if a common space hallway is used to access the DHS facility.

As a slide in my 2005 presentation at the AICPA’s National Valuation Conference stated: “MedPAC also suggested Stark be expanded to cover physician ownership of equipment, or entities that provide equipment and services, used in imaging centers.”  Thus, we have yet another circumstance where MedPAC recommendations to reign in spending in high utilization areas are adopted several years later with catastrophic results for those affected.  To reiterate what I been saying in print and lecture since the turn of the millennium, these changes are foreseeable.  The same thing has already occurred, for example, with the addition of PET services to the Stark regulations effective this past January and we are going to see a need for the wholesale sell-off or closure of facilities violating the anti-markup provision before the effective date of January 2009 just as we did for PET.

When market participants do not appear to respond to the foreseeable changes, a consequential valuation issue arises.  There may be several possible explanations for this.  One is regulatory ignorance, which at least in my view is inconsistent with the requirement under the fair market value standard for “reasonable knowledge of the relevant facts.”  My career-long experience suggests that this does, in fact, account for a large amount of the failure to respond in the physician community, although certainly not in the broader business community of imaging operators.

A second possibility involves the belief that the exit price for the to-be-banned business will compensate for the loss of future operating cashflows.  This is arguably rational under the fair market value standard, but let’s look at it more closely.  With respect to facilities operating under the soon to be defunct IOASE, it is difficult to see that this explanation passes the rational muster because a fire sale scenario invariably results.  The owner-seller has two choices: sell and get something or close and get less than nothing, given the abandonment of the tangible asset investment.  This does not set up a good negotiating scenario nor a strong basis for a going concern premise of value.

Physicians and their advisors structuring future joint ventures in high utilization areas where there is subsequent regulatory change risk should pay careful attention to exit clauses with the nonphysician joint venturer.  Buy-out or buyback language should call for the valuation to be done using a going concern premise of value.  The nonphysician buyer will be concerned about possible subsequent volume drops and the impact on both the valuation and the transaction price.  Careful attention needs to be paid to the language of the agreement as well as the assumptions in the valuation model because the government is known to be concerned about the implications of “future referrals” being the basis for a purchase price when the DHS is located within the selling physician’s office. 

Although very bad news for referring physicians engaged in such structures, it is very good news for hospitals, non-referring physicians, e.g. radiologists and entrepreneurs located within the referring physicians’ service area. 

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