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Management Services Arrangements In Healthcare

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Management Services Arrangements In Healthcare

Growth in the use of management services arrangements in healthcare has been fueled by continued pressure on physician professional fees.  As a result, alternate compensation vehicles are becoming more commonplace, as well as the increasing industry complexity and the need to manage healthcare organizations efficiently, effectively, and in compliance with a litany of local, state, and federal regulations.

Professional Management Services Vs. Clinical Management Services

A major distinction is made between professional management arrangements focused on the provision of business services and clinical management arrangements focusing on clinical outcomes.

Parties to Professional and Clinical Management Services Arrangements

Example: Parties to Professional and Clinical Management Services Arrangements

Specific duties associated with pure professional management services are summarized in the left-most column in the table below. It is common for professional management services to be provided in conjunction with billing services, staff leasing, equipment leasing, and/or the provision of information systems or electronic health records.  Comprehensive professional management arrangements are often coined as “turnkey” management services.

Duties for Professional Management and Related Services

Example: Duties for Professional Management and Related Services

Clinical management is characterized by the physician-led management of a medical service line with performance-based compensation for the achievement of predefined goals.  Because the services are provided entirely by physicians, clinical management arrangements may be regarded as a form of performance-based medical directorships.

Typically, a hospital compensates a group of physicians for clinical management of a hospital-based service line such as surgery, cardiology, or oncology.  However, performance-based medical director arrangements have also been observed for clinical management of post-acute services such as skilled nursing facilities and home health, which are integral to hospital services.

Surgical Co-Management Arrangement Typically Include The Following Performance Metrics:

a) First case on-time start percentage     c) Achieve average room turnover times <30 minutes

b) Maintain 0% infection rate                    d) Maintain >95% patient satisfaction rate on surveys

Hospital Management Services

Professional management of hospital organizations dates back to the founding of HCA and Tenet Healthcare in the 1960s.1 While there are numerous hospital chain operators, few publicly-traded chains act solely as service-only managers without total ownership in the managed hospital.  Quorum Health Resources, now operated as a subsidiary of Community Health Systems Professional Services Corporation, is one such service-only manager.  United Surgical Partners International (USPI), Symbion, Surgical Care Affiliates (SCA), Nueterra, National Surgical Hospitals (NSH), and Texas Health Resources represent a few of the hospital management organizations that do not require 100% ownership.

Additionally, regional and national not-for-profit health systems and “mega-health systems” are regularly engaged in hospital management.  Centralized revenue cycle services, information systems, accounting, group purchasing, finance, human resources, and other administrative services have become the norm for many hospitals in health systems.

HealthCare Appraisers queried a database of Medicare disclosures for the costs of services rendered to hospitals by related organizations.  From this database, HealthCare Appraisers identified 60 hospitals that pay affiliated entities for management services.  The majority of these hospital management arrangements are with reputable, national management companies that also have ownership interests in their managed hospitals.  Of these, HealthCare Appraisers identified 40 hospitals wherein the affiliated healthcare management company was not a 100% owner.  While all the comparable management agreements involve management companies with some ownership interests in the managed hospitals, HealthCare Appraisers specifically excluded agreements for which the management companies own 100% of the managed hospitals.  

Why wholly-owned hospitals were excluded from the data:

1) It is likely that the presence of third-party investors, particularly physician investors, compels management companies to charge management fees that are comparatively more representative of Fair Market Value (“FMV”) than when there are no third-party investors.

2) The incidence of net losses is much higher for the subset of hospitals with 100% management company ownership (11 of 20) compared to all other hospitals (6 of 40).  This trend may suggest that management fees charged to wholly-owned entities are highly influenced by

(a) Strategies by C-corporation parent companies to minimize double taxation by receiving earnings through management fees; and/or

(b) Accounting and tax strategies for offsetting gains and losses among affiliated organizations in various states with differing tax laws.

Critical Access Hospital Management

Management and related administration services are particularly noteworthy for health systems operating Critical Access Hospitals (“CAHs”).  Hospitals in rural areas or Rural hospitals, including those with Critical Access hospital designation, have increasingly “affiliated” or been acquired outright by health systems.  Emergency Entrance.jpg

There are over 1,300 Critical Access Hospitals in the United States receiving special cost-based reimbursement from Medicare, rather than the prospective payment reimbursement paid to all other acute care hospitals. The cost-based reimbursement paid to each CAH hospital is determined based on costs reported in its annual Medicare cost report. Therefore, the cost allocations to CAH hospitals by parent health systems for management and related services directly impact Medicare reimbursement.

Under Medicare regulations:
“Costs applicable to services, facilities, and supplies furnished to the provider by organizations related to the provider by common ownership or control are includable in the allowable cost of the provider at the cost to the related organization. However, such cost must not exceed the price of comparable services, facilities, or supplies that could be purchased elsewhere.”3

This reporting requirement is a reasonable facsimile for FMV opinions. When limited to comport with current healthcare regulations, the term “fair market value” is generally defined as

“the compensation that would be included in a service agreement as the result of bona fide bargaining between well-informed parties to the agreement who are not otherwise in a position to generate business for the other party.”

Suspect “cost shifting” to cost-reimbursed providers has been the subject of numerous cases, varying in magnitude from a $90 million settlement for illegitimate management fees4, to disputed variances for laundry and housekeeping costs as small as $0.60 per patient day.5  In VNA of Albany, Inc. v. BlueCross BlueShield Association United Government Services, the defendant was ultimately found to be non-compliant with exceptions to the related party regulations under both 42 C.F.R. §413.17(d) and PRM Part I, § 1010. Both exceptions require FMV pricing for the related party services6, among other criteria.

Clinical Service Line Co-Management Agreements

Traditional medical director arrangements are intended to create a means for physician-led management of quality and efficiency improvements in acute and outpatient facilities.  However, the unique nature of medical directorships and hourly compensation models are not conducive to generating buy-in with groups of physicians or creating rewards for the achievement of successful clinical outcomes.

Clinical co-management arrangements create the opportunity to overcome the shortcomings of traditional medical directorships by engaging a group of physicians, creating performance-based compensation, and creating the ability to continuously improve with the periodic redefinition of the clinical outcomes as they are achieved.

Female doctor during medical consultation at home.jpeg

Clinical Co-Management Arrangements Composition:

1) A base fee, paid monthly or quarterly, that provides compensation for the day-to-day time of the participating physicians; and

2) An incentive fee paid, in whole or in part, upon the achievement of predefined clinical goals.


Typical Structure of Clinical Co-Management Agreements:
i.  A joint venture entity with both hospital and physician investors;
ii.  A joint venture entity formed by physician investors from different practice organizations; or
iii. The services are provided through an agreement directly between a hospital organization and an existing physician group.
1) 42 CFR §413.17(a); 2) S. ex rel. McLendon v. Columbia/HCA Healthcare Corp; 3) Capital Care Center v. Idaho Department Of Health And Welfare; 4) 42 CFR §413.17 (d)

Medical Practice Management Services

In 2013, HealthCare Appraisers observed a marked increase in the number of management services organizations (“MSOs”) sponsored by health systems and large physician groups providing centralized management, billing, staffing, information systems, and electronic health record (“EHR”) services to independent physician practices.  Additionally, gaining access to affordable EHR systems that are integrated with local hospitals has proven to be a material consideration in major practice decisions and has served to align health systems more closely with physicians. 

Practice Management and Billing

With over 700,000 physicians in the U.S., the market for practice management services is considerably larger than the markets for hospital and ASC management combined.  Accounting services, staffing, and billing services for physician practices are extremely accessible on both piecemeal and bundled basis.  

Organizations providing physician practice management and billing services:

  • Local accounting firms commonly provide bookkeeping, payroll, and other services to physicians.
  • Nearly every major health system in the U.S. is managing owned or affiliated physician practices.
  • IPC: The Hospitalist Company (“IPC”) and Mednax are the largest publicly-traded operators of hospital-based practices. Mednax has over 2,400 providers while IPC has over 2,000 providers.
  • Even Automatic Data Processing (“ADP”), traditionally known for payroll processing, has ventured into medical billing and practice management with its ADP AdvancedMD service line.
  • Interestingly, the markets for medical practice billing services and practice information systems appear to be merging into one industry.  AthenaHealth and Zotec Partners are prime examples of this transition.  Both companies have grown successfully by providing doctor practices with cloud-based billing and information systems, as well as back-office services.

doctor handshake with a patient at doctors bright modern office in hospital.jpeg

A typical key to successful for medical practice management companies is that they provide billing services to clients in conjunction with hosted information and billing systems.  This creates cost savings for physician practices.  Providing information system services for physician practices saves considerable capital that would be spent on purchasing servers, software licenses, help desk support, as well as system upgrades, which tend to be necessary every three years.  

Billing companies can provide billing services much more cost effectively and efficiently when all, or most, of their clients use the same billing systems and practice management systems.  If all medical billing staff only has to use one billing and information system for all doctors’ offices, any biller in the company can work for any medical practice client.   

EHR Donations to Independent Physician Practices

Numerous physicians seeking employment arrangements have articulated fears that the absence of EHR systems in their practices may affect their ability to obtain hospital privileges in the future.  Surprisingly, this is a real source of motivation for some medical professionals seeking employment.

Cerner, Epic, Allscripts, GE Centricity, McKesson, and a plethora of other EHR systems can be very expensive, with a substantial upfront investment in hardware and software, followed by $6,000 to $10,000, or more of licensing and maintenance costs per physician per year for the life of the system.  The first year after EHR implementation is characterized by reduced throughput while staff and physicians adapt.

HealthCare Appraisers has observed MSOs subsidizing up to 85% of the cost of EHR systems to independent physicians and physician groups under the “EHR Donation” safe harbors and exceptions to the federal fraud and abuse laws.  The Anti-Kickback Statute safe harbor is substantially the same as the Stark Law EHR donation exception adopted by the federal Centers for Medicare and Medicaid Services.5  

The Stark law exception states that safe harbor “donors” can pay 85% of the cost of certain technology under specific criteria and exceptions:

  • The donation must be in the form of software, information technology, and training/support services necessary to predominantly create, maintain, transmit, or receive EHRs.
  • The donation cannot be hardware, software to make the hardware function or other personal items unrelated to the physician’s medical practice.
  • The EHR software needs to have an e-prescribing component that meets Medicare Part D standards at the time of donation.
  • The recipient cannot already have items and services equivalent to those provided by the donor, the donated software must be interoperable with other EHR technology at the time it is provided, and the donor cannot restrict interoperability.
  • The EHR donation recipient must pay 15% of the total cost before receiving the donation.
  • Neither the physician nor the physician’s practice may take receipt of items or services as a condition of doing business with the donor.
  • The donor cannot take into account any value of referrals or other business between the parties with determining a physician’s eligibility or amount of donation.

The Stark Law exception and Anti-Kickback Statute safe harbors originally established in 2006 for EHR Donations were extended to renew in December of 2013 through the year 2021.6

5. Healthcare Informatics, The Regulatory Framework for Qualifying EHR Donations, Daniel F. Gottlieb, July 2010

Post-Acute Management Services

Medical team walking down hallway at the hospital.jpegThe last few years have demonstrated significant changes in the post-acute management industry and more significant changes are poised to occur in the near future.

HealthCare Appraisers queried a database of Medicare disclosures for the costs of management services rendered to home health agencies (“HHAs”) by related organizations.  From this data bank, HealthCare Appraisers identified 70 Home Health Agencies that pay affiliated entities for management services.  Of these, HealthCare Appraisers determined 21 HHA joint ventures partly owned by the management companies.  

Then, our valuation experts reviewed the service offerings of the organizations providing HHA management services and determined that they operated centralized financial, information systems, and revenue cycle departments to support their managed Home Health Agencies.  It appears HHA management companies typically provide centralized billing.  This is not the case with management agreements for hospitals, ASCs, and some physician practices, which often rely on the managed entity’s staff for billing.

As with the data analyzed for hospital management arrangements, the relationship between HHA management and billing fees is highly correlated with HHA net revenues.  Performing a similar analysis of management fees for 242 skilled nursing facilities (SNFs) revealed a range with over half of facilities reporting management fees between 2.5% and 5.0% of net revenues.

Three developments likely to increase in post-acute clinical management arrangements:
1)  Bundled Payments:  CMS announced early in 2014 that 232 acute care hospitals, skilled nursing homes, physician group practices, long-term care hospitals, and home health agencies have entered into agreements to participate in the Bundled Payments for Care Improvement (BPCI) initiative to bundle payments for inpatient hospital services and post-acute medical care into a single episodic payment. Bundling payment is one way to encourage doctors, hospitals and other health care providers to work together to better coordinate care for patients, both when they are in the hospital and after they are discharged.
2)  Medicare Reduction:  Medicare has reduced payments to hospitals with excess readmissions for certain diseases. Hospitals that did not meet the required measures sustained a maximum payment penalty of 1% in 2013, which increased to 3% percent in 2015. Heart attack and heart failure were among the first diseases targeted, while chronic obstructive pulmonary disease were added in 2015. Readmissions for all three diseases are highly influenced by patient adherence to medications, attending cardiac or pulmonary rehabilitation, and lifestyle behaviors like smoking and alcohol use.

3)  Accountable Care Organizations (ACOs):  The Accountable Care Cooperative is tracking 612 active Accountable Care Organizations (ACOs) in the U.S. ACOs that minimize per member per month costs through reduced hospital readmissions and other means are entitled to 50% to 60% of the shared savings they generate for Medicare. Post-acute patient adherence to medications and prescribed treatments is fundamental to reducing hospital readmissions and related costs.

Effects of Value-Based Payment on Post-Acute Management

Home Health Agencies, Skilled Nursing Facilities, and primary care physicians are critical providers in post-acute care.  Yet, the vast majority of clinical management programs and co-management programs to date have been with medical specialists like cardiologists, orthopedists, and surgeons for inpatient and acute outpatient hospital services.  

Physician-led management of post-acute medical care is an ideal opportunity to reduce hospital readmissions.  Patient adherence to physician-prescribed regimens for medications, therapies, physical activity, diet, and health behaviors (i.e., smoking and alcohol consumption) are predictive of hospital readmissions.  Patients generally self-manage many elements of these regimens without direct supervision of medical providers.  Management of post-acute services allows physicians to monitor their patients' adherence to prescribed regimens continuously.

Fair Market Valuation (FMV) Of Management Services Arrangements

Determining FMV opinions for management services arrangements is important because healthcare professionals’ financial dealings with referral recipients and referral sources only comply with the Anti-Kickback Statute safe harbor when the terms of the payment agreement are not related to referrals or other business generated by the physician.  

A hospital, health system, or MSO that "under prices" services could be construed to have offered services on terms that were related to the volume or value of the physicians’ referrals.  Conversely, a doctor group that “over prices” services provided could be construed to have received remuneration related to the volume or value of physicians’ referrals.

Valuation Approaches

In formulating an FMV opinion, a healthcare appraiser considers the facts and circumstances of the business and the relevance of each valuation approach.  There are three primary valuation approaches and a variety of specific methods that may be used under each approach.

Income Approach:  The Income Approach is defined by the International Glossary as “a general way of determining a value indication of a business, business ownership interest, security, or intangible asset using one or more methods that convert anticipated economic benefits into a present single amount.”

Cost Approach:  The Cost Approach is defined by the International Glossary as “a general way of determining a value indication of an individual asset by quantifying the amount of money required to replace the future service capability of that asset.”  The Cost Approach is based upon the Principle of Substitution; i.e., the premise that a prudent individual will pay no more for a property than he/she would pay to acquire a substitute property with the same utility.

Guideline (or Market) Approach:  The Market Approach is defined by the International Glossary as “a general way of determining a value indication of a business, business ownership interest, security, or intangible asset by using one or more methods that compare the subject to similar businesses, business ownership interests, securities, or intangible assets that have been sold.” Like the Cost Approach, the Market Approach is based upon the Principle of Substitution.

For FMV of management and co-management arrangements, appraisers consider the results determined under a Market Approach by comparing the services provided to comparable arrangements.  In some cases, a blend of the Market Approach and Cost Approach may be utilized to determine the replacement cost, or substitute cost, that a buyer would pay to receive equivalent services through alternative means.

The Future Of Management Arrangements

The market for professional management and co-management arrangements has become increasingly competitive across healthcare subsectors.  Some management fee rate parity is evident across sectors.  The business and clinical operations of hospitals are thoroughly managed by centralized health systems and physicians alike.  Medical practice management services that offer turn-key management, billing, and hosted information systems may have a competitive advantage over service providers that only focus on one aspect of service.  Growth in the use of post-acute professional and clinical management arrangements is likely to increase, as hospital readmission penalties, shared savings, and post-acute payment bundling continues to develop.  

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