PROVIDER TRANSACTIONS: STRUCTURES, TRENDS, AND HOW TO MINIMIZE HEALTH

REGULATORY RISK

Adam Robison Gregory N. EtzelKing & Spalding, VP of Legal AffairsHouston UTMB Health713-276-7306 409-747-8730 arobison@kslaw.com gretzel@utmb.edu

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Agenda

• Trends in Hospital Affiliation / Acquisitions

• Deal Structures for Hospital Affiliation / Acquisitions

• Legal Risk Associated with Hospital Transactions

• Clinically Integrated Network (CIN) Transactions

• Legal Risk Associated with CIN Transactions

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TRENDS IN HOSPITAL AFFILIATION AND ACQUISITION TRANSACTIONS

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What is Driving Hospital Deals?

• Pressure on Healthcare / Life Sciences companies

• Economic pressures

• Decade of slow economic growth

• Employer pressures on payors

• Consumer sensitivity on price with advent of increased cost-sharing

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What is Driving Hospital Deals?

• Payor pressures on providers

• PPACA

• Medicare cost pressures

• Medicaid cost pressures

• Non-Medicaid expansion states

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What is Driving Hospital Deals?

• All of this means pressure on margins

• New models are needed

• Capital partners

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Hospital Deal Trends: Increased M&A Activity

• Hospital M&A activity saw a significant uptick between 2011 and 2015.

• Deal volumes remain strong in 2016 but have declined relative to 2015. This may continue until after the elections.

Source: PwC, Q1 2016 US health services deals insights

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Increased M&A Activity (cont’d)

Source: Irving Levin Associates, Health

Care Deal News, April 27, 2015

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Hospital Deal Trends: Regional Systems

• Trend toward more regional (as opposed to single market) hospital systems.

― According to American Hospital Association data, the number of hospitals in systems increased by 16.5% for the 10-year period ended 2010. Only increased since.

• A number of factors are driving this.

― E.g., Shift to population health management, ACO development

• Payor consolidation.

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Macro Drivers of Industry Transformation

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Macro Factors – Proactive

• Desire to create/be part of a larger healthcare system to:

― Increase market share/patient panel.

― Create synergies/economies of scale.

― Enhance physician networks/referral patterns.

― Treat patients in best place for their care.

• Enhance position of hospital for medium/long term by joining a more regional, statewide or national system.

Macro Factors – Reactive

• Payment Reductions in the Coming Years:

― Hospital market basket update reductions continue.

― Reductions for hospital readmission rates.

― Reductions in Medicare DSH payments for hospitals.

― Sequester continues and has been extended.

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Macro Factors – Reactive (cont’d)

• Cuts to Medicare Advantage Plans

• Medicare moratorium of off campus provider-based sites – trend toward site-neutral payments

• Medicaid DSH cuts

• Other payment reductions coming?

― Budget negotiations continue on Capitol Hill and most observers agree that healthcare is a prime target.

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Macro Factors – Reactive (cont’d)

• Cumulative rate cuts associated with PPACA are staggering and impact alone will drive consolidation across the industry.

Macro Factors – Reactive (cont’d)

• Many states are not expanding Medicaid.

Distressed Hospitals

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Increased Hospital-Physician Alignment

• Challenging practice economics are leading more independent physicians to:

― Seek Hospital/Health System Employment

― Drop all Medicare and Medicaid Beneficiaries

― Convert to a “Concierge” Practice

― Join/Create an IPA

• Population health requires an increased level of integration and alignment to be successful.

• Changes in care delivery models require a legal mechanism to reward and incentivize physicians.

• Strategic initiatives and new competitors are emerging that are all competing for a piece of the same premium.

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Hospital Physician Alignment

• Hospital Systems are better able to take advantage of economies of scale necessary to make new alignment models “work.”

• Large catchment area needed for population health management models.

• Same is true with respect to accountable care organizations.

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DEAL STRUCTURES FOR HOSPITAL ACQUISITIONS/ AFFILIATIONS

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Hospital Deal Structure Types

• Management Agreement

• “Collaboration”

• Joint Operating Agreement

• Joint Venture

• Co-Membership Agreements

• Membership Substitution

• Full Acquisition of Assets or Stock

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Deal Structure Continuum

• Partnership goals and objectives inform the structures to be evaluated.

• Partnership goals lead towards more fully integrated structures

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Management Agreement

Party 1 Party 2

Sub A Sub B Sub C

• Interim step towards a more complete integration.

• One party manages one or more of the other party’s hospitals, physician groups, or other healthcare services.

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Collaboration

Party 1 Party 2

Sub A Sub B

• Parties form a company that could share clinical best practices, purchasing, optimize service lines, consider forming accountable care organizations and other services and discuss mutually applicable concerns.

Sub X Sub Y

Collaboration

Agreement

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Joint Operating Agreement

Party 1 Party 2

Sub A Sub B

• More integrated than a collaboration.

• All hospital management and other health system activities are vested in the JOA.

• Ownership of assets and membership interests remains with current parents.

• Considerations

Sub X Sub Y

Joint Operating

Agreement$$$ distributions $$$ distributions

• Governance

• Credit/Capital

support

• Governance

• Credit/Capital

support

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JOC/Virtual Merger-Closer Look

• JOC is a separate entity formed to manage and operate subject Service Lines― LLC

― Jointly owned by Hospital A and Hospital B; percentage ownership based on valuation

• Each member continues to own all assets comprising respective subject Service Lines

• JOC would contract with payors for entire subject Service Line

• A member’s ERDs (if applicable) may not be affected

• Debt structures remain separate

• JOC interests are non-transferable

• Memorialized by Joint Operating Agreement (JOA)

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Co-Membership Agreement

Party 1 Party 2

Sub A Sub B

• Each party acquires a membership interest in the other party’s hospital operating companies.

Sub X Sub Y

Co-Membership Agreement

49/51% Nonprofit

Membership Interest

in each Sub

49/51% Nonprofit

Membership Interest

in each Sub

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Stock Sale or Member Substitution

BEFORE

XYZ Company

ABC Healthcare Entity

“Buyer” “Seller”

Members or Shareholders of

ABC Healthcare Entity

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Stock Sale or Member Substitution

XYZ Company

(Sole shareholder or

member of ABC)

ABC Healthcare Entity

AFTER

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Asset Purchase Transaction

• Structure

― Select assets and liabilities (careful scrutiny)

― Purchase price

― Transfer of assets

• Due diligence – is less required?

• Issues with successor liability

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HOSPITAL TRANSACTIONS: LEGAL ISSUES AND WAYS TO REDUCE RISK

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Hospital Transactions: Legal Issues

Hospital transactions are guided by certain legal principles, such as laws regarding:

• Tax Laws

• Health Regulatory Laws (federal and state)

• Antitrust Laws

• Texas Constitutional (for Texas governmental entities)

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Guiding Legal Principles: Tax

1. Tax Issues Related to JOCs

If the “virtual income” of the JOC is not exempt from tax, it could result in taxable income, unrelated business income tax (UBIT), loss of the members’ exemptions or other adverse consequences under the members’ tax-exempt bond financings

JOC will likely not qualify as a tax-exempt organization in its own right

But the income of the JOC may qualify for exemption as an “integral part” of its 501(c)(3) members if:

JOC performs essential services for the exempt members which (if performed by the members) would not be UBIT

The relationship among the exempt members and the JOC is equivalent to a parent-subsidiary

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Guiding Legal Principles: Antitrust

“I remain very concerned about the rapid rate of consolidation among healthcare providers. The number of hospital transactions continues to rise . . . Transactions involving physician practices – both mergers between independent physicians as well as hospital acquisitions of physician groups also continue to increase. In addition, we have seen providers increasingly pursue alternatives to traditional mergers such as affiliation arrangements, joint ventures, and partnerships, all of which could also have significant implications for competition.”

-FTC Chairwoman Edith Ramirez, May 12, 2016

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Hospital Mergers: Overview

• FTC conducts antitrust review of most hospital mergers.

― HSR-reportable and non-reportable transactions.

― Consummated and unconsummated transactions.

• Most hospital mergers do not cause competitive harm according to the FTC.

― Majority of hospital mergers are allowed to close in first 30 days.

― FTC assesses effect on competition, including likely improvements in quality of care and other efficiencies.

• FTC files federal-court (§ 13(b)) and administrative complaints against transactions it believes are likely to “substantially lessen competition” (Clayton Act §7).

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Hospital Mergers: Historical Context

• FTC litigation success in 1980s― American Medical International (1984).

― HCA (1985) – affirmed by 7th Cir., cert. denied.

― U.S. v. Rockford (N.D. Ill. 1989), affirmed by 7th Cir., cert. denied.

― FTC v. University Health (11th Cir. 1991).

― Non-profit hospitals subject to antitrust law.

• Failures in the 1990s― FTC v. Freeman Hospital (8th Cir. 1995).

― FTC v. Butterworth Health (6th Cir. 1997).

― US v. Mercy Health Servs. (8th Cir. 1997).

― US v. LIJ (E.D.N.Y. 1997).

― FTC v. Tenet Healthcare (8th Cir. 1999).

― California v. Sutter Health System (N.D. Cal. 2001).

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Hospital Mergers: Historical Context

• 2002: FTC Hospital Merger Retrospective Project.

― Analyzes effects of consummated hospital mergers.

― Concludes consolidation led to increased prices.

• Resurgence of FTC hospital merger enforcement:

― Evanston (2007).

― Inova/Prince William (2008).

― ProMedica/St. Luke’s (2012).

― OSF/Rockford (2012).

― Phoebe Putney/Palmyra Park (Ongoing).

• But not all mergers blocked…Example: Yale-New Haven Hospital/Hospital of Saint Raphael transaction (2012).

― Combination of the two closest hospitals in the New Haven, CT area.

― Investigations closed by the FTC and the CT AG.

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Hospital Mergers: Recent Developments

• After a winning streak, FTC loses three in 2016 at District Court level (but Hershey/Pinnacle reversed by 3d Circuit).

― Advocate/North Shore (IL) (on appeal).

― FTC economics model heavily criticized.

― FTC’s overly narrow geographic market definition was that it excluded destination hospitals.

― Hershey/Pinnacle (PA) (reversed by Third Circuit 9/27/16).

― Rejected FTC’s narrow geographic market.

― Criticized FTC’s enforcement policy post-ACA.

― Reversed by Third Circuit

― Cabell/St Mary’s (WVA)

― WVA state legislature defies FTC and approves deal.

Penn State Hershey Medical Center (Hershey) and PinnacleHealth System

• Decision primarily based on conclusion that geographic markets should primarily be defined on evidence from payors and payors made clear that the transaction would lead to loss of competition.

• The court concluded that the government met its burden for a preliminary injunction and that the defenses advanced by the merging parties (e.g., efficiencies) were inadequate to overcome the presumption that the merger would be anticompetitive.

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Hospital Mergers: Substantive Issues

• Documents are key:

― “An affiliation could “stick it to employers, that is, to continue forcing high rates on employers and insurance companies.” – FTC v. ProMedica, St. Luke’s presentation to Board; cited by Court’s initial decision.

― The merger “would be an opportunity to join forces and grow together rather than compete with each other.” – In the Matter of Evanston Northwestern Healthcare Corp., presentation made to hospital board.

Guiding Legal Principles: Healthcare Regulatory Laws

Federal Laws

• Anti-kickback Statute

• Stark Law

• CMP/Gainsharing

• HIPAA

• Enrollment

State Laws

• Texas Non-Solicitation Statute

• State Anti-referral Laws

• Licensure

• Texas Constitution

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Guiding Legal Principles: Texas Constitution

• Tex. Const’n, Art. III, Sections 49, 50, or 51

― §49 - “[n]o debt shall be created by or on behalf of the State.”

― §50 - Legislature lacks power to lend the credit of the state to a private person

― §51 - Legislature lacks power to make any grant of public moneys to a private person

• Public Purpose Exception: Sections 50 and 51 are not violated if (i) funds expended for public purpose, (ii) gov’t body retains control to ensure public purpose achieved, and (iii) the public receives adequate consideration.

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CLINICALLY INTEGRATED NETWORK TRANSACTIONS

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What Are Clinically Integrated Networks?

• Collaboration among physicians, hospitals and other providers to operate an active and ongoing program of clinical initiatives to improve the quality and delivery of health care services, leading to greater efficiency in care delivery and cost savings.

• Links multiple health care components a patient might encounter: physician practices for primary and specialty care, hospitals for acute or chronic conditions that erupt, and post-acute care for conditions of aging or recovery from illness.

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Why Form CINs?

• Movement towards population health, i.e., managing populations instead of individuals.

• Paradigm shift away from FFS payment regime towards reduced costs and improved quality of care grounded in performance and value based payment models.

• Legislative and regulatory framework arising out of PPACA.

• To participate in MSSP, other CMS ACO models, and analogous commercial programs.

• Ability to contract jointly with commercial payors even though not economically aligned.

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Triple Aim of Clinical Integration

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What is the Prime Objective of a

CIN?

The Triple Aim

• A framework by which health

care providers:

1. Increase the health of a

population

2. Improve the experience of care

3. Lowering per capita health care

costs

Population Health

Per Capita Cost

Experience of Care

CINs: Legal Structures

• Independent Practice Associations (IPAs)

― Networks of independent physicians that contract with MCOs, employers, and others.

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CINs: Legal Structures

• Physician / Hospital Organizations (PHOs)

― Joint ventures between hospital(s) and physicians who typically have admitting privileges at the hospital(s). Sometimes engage in joint contracting with MCOs.

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CINs: Legal Structures

Accountable Care Organizations (ACOs)

― Groups of physicians, hospitals, and other providers who

collaborate to coordinate quality care to patients.

― Many participate in MSSP or other CMS ACO models.

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CIN: Legal Structures

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CIN/ACO

Hosp/Systems

PHO/IPA

Contracted PCPs*

Contracted Specialists*

CMS PAYERS

Other

Providers

CIN Legal Considerations

• Stark and Anti-Kickback Statute

― Risk Sharing Arrangements Exception

― MSSP Waivers (Pre-Par, Par, Distribution, Compliance with Stark, and Patient Incentives)

― Next Generation Waiver

• Antitrust Laws

• Tax Laws

• Insurance License Laws (Business / Insurance Risk)

• Texas Constitution (Art. III, Secs. 49, 50, and 51)

• Other State Laws

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King &

Spalding,

LLP

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MSSP: CMS and OIG Waivers

• The “purposes of the shared savings program” means one or more of the following:

― Promoting accountability for the quality, cost and overall care for the Medicare patient population

― Managing and coordinating care for Medicare FFS beneficiaries through an ACO

― Encouraging investment in infrastructure and redesigned care processes for high quality and efficient service delivery for patients

• Waiver standard: Must be reasonably related to one purpose of SSP

― Less restrictive than proposed rule (“necessary for and directly related to ACO purposes”)

King &

Spalding,

LLP

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MSSP ACOs: IRS Guidance

• IRS Notice 2011-20 addresses the impact of ACO participation on tax-exempt status

― MSSP consistent with the charitable purpose of lessening the burdens of government

― IRS evasive regarding ACOs that contract with commercial payors (may not lessen burdens of government)

― Single member LLC vs. nonprofit

• IRS Fact Sheet (October 20, 2011) clarifies some aspects of prior notice, such as:

― Exempt entities participating in qualifying ACOs organized as partnerships do not need to control those organizations to remain consistent with charitable purposes, given nature of SSP

― Application of unrelated business rules to non-SSP activities of ACOs will turn on facts and circumstances

King &

Spalding,

LLP

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MSSP: FTC/DOJ Guidance

• Presumed clinically integrated and “rule of reason” antitrust analysis applies for ACOs

― Anticompetitive risks raised by ACOs

― Potential offsetting efficiencies

• No mandatory pre-approval of ACO by FTC/DOJ

• Antitrust “safety zone” for an ACO’s independent participants with less than 30% market share of their service(s)

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Antitrust Scrutiny of Physician Networks: Overview

• Consolidation through the formation of physician networks (i.e., clinically and/or financially integrated networks that engage in joint contracting with commercial payors) has grown substantially in the past few years.

• Guidance from the FTC and DOJ (the Healthcare Statements, ACO Statement; Advisory Opinions, and Workshops/Speeches) generally helpful but does not cover complexity associated with formation of multi-provider networks. For example: Participation in MSSP ≠ 𝐀𝐧𝐭𝐢𝐭𝐫𝐮𝐬𝐭 𝐈𝐦𝐦𝐮𝐧𝐢𝐭𝐲

• Key antitrust issues:

― How integrated do I have to be?

― How big can I get?

― Geographic area of competitive overlap?

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Antitrust Scrutiny of Physician Networks: Framework

• For independent providers to engage in joint contracting with commercial payors, the providers must achieve “integration that is likely to produce significant efficiencies that benefit consumers, and joint contracting must be reasonably necessary to realize those efficiencies.”

• Both the FI and CI models are based on the formation of physician networks, yet can also be adopted by hospitals.

• The messenger model is an alternative to joint contracting and can be first step toward CI/FI.

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Antitrust Scrutiny of Physician Networks: Financial Integration

• Network providers

― Share substantial system-wide financial risk through their participation in the network.

― Financial Risk creates incentives for the participation providers.

― Incentives are to jointly control costs and improve quality by managing the provision of services.

• Network’s fee schedule is reasonably necessary to obtain significant efficiencies through the network.

• All members need to be at substantial financial risk.

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Antitrust Scrutiny of Physician Networks: Financial Integration (cont’d)

• Risk-sharing involving the use of significant financial incentives (substantial withholds in the 15-20% range) tied to system-wide clinical/cost-containment targets for physicians or hospitals that participate to achieve, as a group, specified cost-containment goals.

• Other examples include agreements for “capitated” compensation and agreements to provide designated services for a pre-determined percentage of premium or revenue.

• A shared “bottom line” of revenues (profits and losses) may also be sufficient risk sharing.

• Targets improve quality and/or lower cost.

• Targets must be ones that members are not already meeting on their own – i.e., the network is necessary to achieve the targets.

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Antitrust Scrutiny of Physician Networks: Clinical Integration

• CI involves health care providers working together interdependently to:

― Pool infrastructure and resources.

― Develop, implement and monitor protocols, “best practices” and other processes that improve the quality care in a more efficient/better manner than they could accomplish absent the network.

• Any agreement concerning price or other terms or conditions of dealing entered into collectively by the providers is reasonably necessary to obtain significant efficiencies through the CI collaboration.

• ACO approved under CMS regulations may qualify as sufficient CI, provided that the same mechanisms are in place for all payors.

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Antitrust Scrutiny of Physician Networks: Clinical Integration

• Typical characteristics

― Emulates a single, merged system.

― Significant infrastructure to support sharing of clinical information.

― Clinical guidelines/protocols.

― Efficiency, quality and cost goals or benchmarks to monitor and control utilization of health care services that are designed to control costs and assure quality of care.

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Antitrust Scrutiny of Physician Networks: Competitive Effects

• Even if network is substantially financially or clinically integrated, the network may have substantial antitrust exposure if it has “market power.”

• Market share by service in relevant market.

• Exclusive contracting is the key issue.

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Antitrust Scrutiny of Physician Networks: Lessons Learned

• Good:

― Improving quality.

― Lowering the delivered cost of healthcare.

― Improving the efficiencies of your system performance.

• Neutral:

― To obtain a higher level of reimbursement to reward the network for its improvements in quality (P4P concept).

• Bad:

― To obtain leverage against managed care.

― To band together to obtain higher rates.

― To be in compliance with federal antitrust law with no real buy-in from providers on the need to improve quality.

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Reducing Risk

• Sell transaction to payors and control document creation.

• Develop a payor and employer contact plan.

― You will want to know what payors will say before they hear from the FTC.

― Without payor complaints, it will be difficult for the FTC to challenge most transactions.

• Identify your supporters.

• Alleviate concerns.