This article reprinted with permission of The Connecticut Law Tribune, September 21, 1998 edition.
In response to economic and competitive pressures, physicians are banding together in larger groups, are performing new services and are forming new affiliations.
Marcus Welby was the epitome of the ideal family physician to millions of Americans who watched the television show from 1969 to 1976. That idealized version of the family physicianCin practice for himself, unhurried and always willing to chat, with a whole town of life-long, fiercely loyal patientsCis all but unrecognizable in today=s health-care environment, for a variety of reasons. With the recent death of Robert Young, the actor who portrayed Marcus Welby, it seems appropriate to reflect on the demise of Marcus Welby-type practices and the new paradigms for the delivery of medical services by physicians.
More Groups, Larger Groups
The change most immediately apparent to patients is the prevalence of group practices, particularly large ones. In the past, solo practices were the standard. Today, only roughly one quarter of physicians are engaged in solo practice. Although some rugged individualists will always remain in solo practice, it becomes increasingly unlikely that new medical school graduates will hang out their own shingles as solo practitioners. The number of physicians in each group practice is also increasing.
According to the American Medical Association, the average number of physicians in a group practice is now more than 14, and the proportion of physicians practicing in large groups of 20 or more is now 10 percent. In addition, "groups without walls" physicians who do not practice in a single location, but have a single tax identification number and integrated operations are increasingly common and can be very large. For example, in Connecticut alone, one group is composed of roughly 150 primary care physicians, and another group has approximately 140 OB/GYNs. The prevalence of group practices and the large size of group practices is an adaptive response to economic pressures, particularly those created by managed care. Larger groups enable physicians to compete more effectively in the marketplace by allowing physicians to spread overhead more effectively and enabling them more easily to absorb fee pressures exerted by managed care and Medicare. In addition, larger groups are better able to hire and absorb the costs of management services needed to deal with the requirements of managed care. Finally, larger groups are more likely to obtain, and retain, the managed-care contracts considered essential in this environment. In fact, a 1995 study found that only 3 percent of groups with 25 or more physicians were rejected for participation by managed care plans.
THE >PPMs=
Physician practice management companies (PPMs) have begun the process of transforming physician practices from Main Street to Wall Street. Large PPMs such as PhyCor and MedPartners pioneered an approach known as the physician equity model, which separates the ownership of the tangible assets of the practice from the delivery of medical services. The PPM purchases the tangible assets of the medical practice for stock, cash or some combination thereof. The medical practice then signs a long-term management contract and restrictive covenant with the PPM, which provides management services and practice assets to the medical group in exchange for a fee (typically a percentage of net practice revenues). The physicians receive the balance of the revenues, less other expenses. The intent of the arrangement is to maximize practice revenues by increasing efficiency and productivity; to reduce expenses through improved management of personnel, contracting and information systems; and to free physicians from the hassles of running a practice, enabling them to focus on delivering care. In theory, at least, it is a win-win arrangement.
In many cases, however, the promise has not been realized. Publicly traded PPMs became the darlings of Wall Street in the early 1990s. By buying physician practices at five to eight times earnings, and trading on the stock exchange at considerably higher multiples, these companies= stock prices increased rapidly as their acquisition of medical practices expanded. But then the bubble burst. The stock prices of MedPartners and PhyCor both plummeted after a failed merger in 1997. FPA Medical Management, until recently one of the largest PPMs in the country, traded last October at $40, but was down to 25 cents this past July when it filed for bankruptcy. Typically, PPM failures are characterized by too much growth too fast, a willingness to accept excessive financial risk from HMOs through capitation contracts, inability to control costs adequately and a narrow focus on increasing revenues through practice acquisitions.
PPMs are not inherently flawed, however, and many are successful, particularly ones that focus on single-specialty practices, such as obstetrics and gynecology, oncology, eye care, pediatrics and workers= compensation. The real test for all PPMs is whether they will be able to increase the efficiency of medical practices by controlling costs while enhancing care.
Another test for the PPM industry will be its ability to withstand some recent legal challenges. This past April, the Office of Inspector General of the U.S. Department of Health and Human Services opined in an advisory document that a proposed management services contract between a PPM and a physician practice, which provided for PPM compensation based on a percentage of net practice revenues, could constitute illegal remuneration as defined in the federal anti-kickback statute. That statute, codified at '1128B(6) of the Social Security Act, makes it a criminal offense to pay remuneration to induce the referral of business covered by a federal health-care program.
Although the proposed arrangement included certain features that might not be present in all management arrangements (such as PPM responsibility for marketing and network development), the OIG advisory opinion is still troublesome because it appears to state that safe harbor protection is not available to any management arrangement if it has revenue-based compensation. This opinion is clearly out of step with the current status of the physician-management industry, where such arrangements are the norm and are increasing.
Revenue-based PPM compensation has also been challenged at the state level. In late 1997, the Florida Board of Medicine determined that payments of a percentage of income by physicians to a PPM constituted fee splitting, which could subject the physicians in question to disciplinary action. The board=s decision has been appealed to the Florida District Court of Appeals. A decision upholding the board=s ruling would send shock waves throughout the state, where it is estimated that 500 to 1,000 such management contracts are in place.
Hospital-Owned Practices
Hospitals are a leading competitor of PPMs for the purchase of physician practices. As the demand for traditional hospital in-patient services has declined as a result of managed care and medical technology, hospitals are reconfiguring their services to include more ambulatory and rehabilitative services. The purchase of physician practices helps meet this objective by securing the hospital=s physician referral base and by expanding the traditional menu of medical services offered by a hospital.
Hospitals use a variety of methods to acquire medical practices. Traditionally, the hospital acquired all the assets of the physician practice and hired the physician as an employee on a salary and/or incentive compensation basis. Lately, however, hospitals are increasingly using a variation of the physician-equity model employed by PPMs, by acquiring only the tangible assets of the physician=s practice, structuring a long-term management contract between a hospital subsidiary and the practice, and leaving the physician as an employee of the practice, with his or her compensation based on revenues generated by the practice.
The purchase of a physician practice by a hospital may implicate the anti-kickback statute described above, if the government perceives the hospital=s payment for the practice to be in return for physician referrals.
The parties must therefore be careful how they characterize the acquisition in the applicable documents and must take care to have the practice properly appraised to establish fair market value. (A payment in excess of fair market value can be construed to be payment for referrals, in violation of the anti-kickback statute.)
In addition, the recruitment of physicians by tax-exempt hospitals raises some important federal income tax issues for hospitals that are exempt under '501(c)(3) of the Internal Revenue Code of 1986, as amended. Tax-exempt hospitals are prohibited from engaging in activities that result in their net earnings inuring to the benefit of a private individual or engaging in activities that further a private rather than a public interest. Failure to adhere to these requirements can lead to the loss of a hospital=s tax-exempt status. Because these prohibitions may be implicated whenever a hospital provides incentives to physicians to join its medical staff, tax-exempt hospitals must be cautious regarding the type and scope of incentives they provide and the terms on which they purchase physician practices.
The challenges and promises of hospital-owned and managed practices are comparable to those of PPMs. Hospitals, at least nonprofit ones, can claim a stronger allegiance to patient care inasmuch as they have no shareholders to satisfy. On the other hand, most PPMs can claim a stronger background in practice management and, in many cases, can point to stronger financial profiles.
Office-Based Surgery
Surgery performed right in the doctor=s office is the latest step in a decades-old trend of moving surgeries from an in-patient to an outpatient setting. Since 1980, the percentage of surgeries performed in an outpatient setting has increased fourfold. Until recently, however, the outpatient setting was based at a hospital, or less frequently, at a free-standing ambulatory surgicenter. Now, howeverCparticularly in certain specialties like orthopedics and dermatologyCthe surgery increasingly takes place in the physician=s office.
This latest development has been made possible by improvements in anesthesia and the development of less-invasive surgical procedures. But the driving forces behind it include increased convenience to the patient and physician, reduced costs, improved efficiency and, last but not least, an opportunity for physicians to increase their revenue by billing for the technical fees previously billed by surgery centers and hospitals.
Connecticut continues to impose certificate-of-need requirements on the establishment of free-standing ambulatory surgery centers and those established by hospitals, but there is typically an exception for office-based surgery facilities that are part of a physician=s practice where the use of such facilities is limited to physicians in the practice. Not surprisingly, the expansion of in-office surgery is opposed by hospitals and free-standing surgical facilities.
Because of this opposition and the proliferation of in-office surgery centers, regulators are watching this trend carefully.
Telemedicine
As a consequence of modern technology, physicians can now examine a patient at a distant site through telecommunication using telephones, computer and/or cable television technology. Telemedicine allows a physician to examine and monitor certain types of patients more effectively and can prevent unnecessary travel by certain patients for whom travel might be burdensome or difficult. Telemedicine also permits physicians to provide better medical service to patients in remote or rural areas.
Although telemedicine raises some interesting licensure, liability and confidentiality issues, the federal government has begun compensating physicians for professional services furnished via telecommunications systems to Medicare beneficiaries residing in certain rural areas (albeit rather slowly and, according to many practitioners, inadequately). In addition, Congress has requested a study on the feasibility of expanding the coverage of telemedicine medical services to all Medicare beneficiaries.
Connecticut has addressed the development of telemedicine by requiring that any physician who provides medical care through electronic communications or interstate commerce to anyone in the state must be licensed to practice in Connecticut. (Exceptions apply for sporadic consultations with an instate physician and for educational consults.) Many other states have adopted similar licensing requirements. Telemedicine has the potential to increase the efficient delivery of certain health-care services. The ability to charge for telephone consultations will also allow physicians to generate revenue from a service for which they cannot generally charge today. It will be interesting to observe whether telemedicine practice patterns will vary under capitation and fee-for-service payment systems.
Conclusions
The economic and competitive pressures exerted on physicians by managed care are enormous. As a result, physicians are banding together in larger groups, are performing new, revenue-generating services, and are affiliating with hospitals or for-profit management companies. Opinions vary as to whether any or all of these developments have improved patient care or physician satisfaction. For better or worse, nowadays the most likely place to see a Marcus Welby-type physician practice is on reruns.
Robert G. Siegel is a partner in the Hartford office of Day, Berry & Howard, and is chairman of the firm's Health Care Practice Group. Priya S. Morganstern is counsel in the Hartford office of Day, Berry & Howard, and practices in the areas of health-care and tax-exempt organizations.