1. Valuation of Physician Practices Proceed with Caution! www.aicpa.org/fvs

2. Forensic and Valuation Services Section DISCLAIMER The views expressed by the presenters do not necessarily represent the views, positions, or opinions of the AICPA or the presenters respective organization. These materials, and the oral presentation accompanying them, are for educational purposes only and do not constitute accounting or legal advice or create an accountant-client or attorney-client relationship. www.aicpa.org/fvs 2 3. Forensic and Valuation Services Section Panelists David Cranford, CPA Decosimo Advisory Services DavidCranford@decosimo.com 423-756-7100 Shannon Farr, CPA/ABV/CFF Decosimo Advisory Services ShannonFarr@decosimo.com 423-756-7100 www.aicpa.org/fvs 3 4. Forensic and Valuation Services Section Focus of Todays Presentation In this webcast, experts in physician practice consulting and valuation will discuss the unique operational and financial aspects of physician practice and the related implications on valuation. Practical applications for use in the valuation of physician practices will be provided. www.aicpa.org/fvs 4 5. Forensic and Valuation Services Section Basic Concepts Underlying Physician Practice Revenue www.aicpa.org/fvs 5 Primary Care Internal Medicine, Family Practice and Pediatrics Revenue is based almost completely on the office visit and related office testing How many patients is the physician going to see? What type of patients is the physician going to see Primary Care physicians can specialize Hospitalists Dermatology Endocrinology Allergy / Immunology Other 6. Forensic and Valuation Services Section Basic Concepts Underlying Physician Practice Revenue www.aicpa.org/fvs 6 Testing What makes economic sense? Pediatrics Strep, CBC Internist Wider range of chemistry profiles, chest x-rays Specialists - Procedures 7. Forensic and Valuation Services Section Basic Concepts Underlying Physician Practice Revenue www.aicpa.org/fvs 7 Invasive Surgeons and Specialists Revenue is based on the procedures If they are not in the operating room, cath lab or outpatient procedure room, they are not generating income Usually have high end diagnostic services MRI CT Scanner Endoscopy How many procedures are performed Maintain an office to accept referrals, screen patients and follow up visits Efficiency of schedule drives revenue 8. Forensic and Valuation Services Section Three most common payment methods that health plans use to pay physicians are: Fee for service physicians are paid for every visit and test that they provide based on the usual and customary charges of physicians in the local area - Uncommon seen in out of network payments Discounted fee for service - physicians are paid for every visit and test they provide based on a fee schedule - Most common Capitation - physicians are paid a fixed amount per enrollee, not per service, on a monthly basis for the patients assigned to them or the group *Note - Physicians maintain a schedule of charges based on CPT codes that exceed the rates paid by payors. This is done to maximum payments based on a charge. Basic Concepts Underlying Physician Practice Revenue www.aicpa.org/fvs 8 9. Forensic and Valuation Services Section Payment Adjustments: Withhold - a percentage of the capitation or fee-for-service payment is withheld by the payor to decrease risk of loses where patient premiums do not cover payments to providers. Withhold funds may be paid to physicians based on a contracted formula. Retrospective utilization target Physicians are incentivized to control utilization and provide fewer and/or less costly services. Provide early detection and treatment to lower total cost of care. Physician payments can be adjusted based on the contracted goals or removed from the payor health. Basic Concepts Underlying Physician Practice Revenue www.aicpa.org/fvs 9 10. Forensic and Valuation Services Section Payment Adjustments: Payor Bonuses - physicians can be paid extra payments at the end of the year for keeping the health plan's payments, particularly to specialists and hospitals, below a pre-determined budget or utilization target. - May also be determined from measures of patient satisfaction, access and outcomes of care. In some bonus systems, physicians may have to return payments to the health plan if utilization is above a target. Retrospective payor audits - Health insurers sometimes perform audits of payments they make to physicians. An insurer may conduct a retrospective audit for several reasons, including high service volume, coding issues (E&M upcoding), and medical necessity. Basic Concepts Underlying Physician Practice Revenue www.aicpa.org/fvs 10 11. Forensic and Valuation Services Section Basic Concepts Underlying Physician Practice Revenue www.aicpa.org/fvs 11 The practice income can include revenues other than patient collections Investment in ambulatory care centers Medicare/Medicaid payment for Electronic Health Record implementation Rental income from subletting of office space Investment income Medical record copying Expert testimony Other On a cash basis, reported income on reporting period can be impacted by collection of accounts receivable related to prior periods. 12. Forensic and Valuation Services Section Basic Concepts of Expenses Generally Present in a Physician Practice www.aicpa.org/fvs 12 Physician practices are generally operated on a cash basis. Accordingly, expenses are presented in the cash basis financial statements when paid. Large payments paid annually are generally not amortized. Examples of large expenses are malpractice and property taxes. Non-Provider expenses can range from 45% - 65% of revenues based on specialties 13. Forensic and Valuation Services Section Basic Concepts Underlying Physician Practice Revenue www.aicpa.org/fvs 13 Revenues can be impacted by changes in payor methodologies requirement to use contracted lab of payor, bundling of charges, precertification of diagnostic testing (MRI),etc. Delays in payments from payors can be impacted related to the following: Denied claims Appealed claims Timely filing of claims Precertification of procedures and referrals Program audits of Medicare/Medicaid 14. Forensic and Valuation Services Section Basic Concepts Underlying Physician Practice Revenue www.aicpa.org/fvs 14 Insurance plans with high deductibles /HSA (Health Saving Accounts) are impacting both volumes and collections significantly Difference between charge amount and fee schedule not recognized until payment is received. This difference is called a contractual adjustment. It is not the same as a bad debt. Accurate reporting dependent upon correct employee input. Large number receivable balances make error search and discovery difficult. 15. Forensic and Valuation Services Section Basic Concepts Underlying Physician Practice Revenue www.aicpa.org/fvs 15 Credit balances reported in revenue. In the case of a tax basis taxpayor, taxes would be paid in the year the credit occurred and income reduced in the year the credit refunded. The use of Nurse Practioners (NP), Physician Assistants (PA), Orthopedic Assistants, Certified Nurse Midwife (CNM) are becoming more common in physician practices. The billings for these services is complex and highly regulated 16. Forensic and Valuation Services Section Basic Concepts Underlying Physician Practice Revenue www.aicpa.org/fvs 16 CPT Codes Charges coded as CPT ICD-9 codes commonly used codes (ICD-10 transition is very expensive and most providers have not upgraded to the ICD-10) Current procedural terminology, registered trademark of the AMA Describes why the service was provided Describes the service that was rendered for billing purposes Used by insurers to determine the amount of reimbursement a practitioner will receive from the insurance company 17. Forensic and Valuation Services Section Basic Concepts Underlying Physician Practice Revenue www.aicpa.org/fvs 17 ICD-CM Coding Rules List the principal diagnosis first If diagnosis is not established, code for symptom Dont code for rule-out diagnosis Dont code a diagnosis that does not apply to the present visit Preventative E/M codes linked to V codes 18. Forensic and Valuation Services Section Basic Concepts Underlying Physician Practice Revenue 18 CPT Code History Exam Management Time 99211 Minimal Minimal Minimal 5 minutes 99212 Problem focused Problem focused Straightforward 10 minutes 99213 Expanded problem focused Expanded problem focused Low complexity 15 minutes 99214 Detailed Detailed Moderate complexity 25 minutes 99215 Comprehensive Complex High complexity 40 minutes 19. Forensic and Valuation Services Section Basic Concepts of Expenses Generally Present in a Physician Practice www.aicpa.org/fvs 19 Significant non-physician expenses related to Physician Practices include: Staff salary expense Malpractice insurance based on physician specialty and region of the country Rent Property taxes (if not included in the rent) Information Technology/Electronic Health Records Marketing cost (increasing due to competition ) 20. Forensic and Valuation Services Section Basic Concepts of Expenses Generally Present in a Physician Practice www.aicpa.org/fvs 20 Physician practices can be categorized as follows: Operating Expenses Fixed - Rent - Contracted services - Cleaning services - Insurance - Property taxes - Utilities - Other 21. Forensic and Valuation Services Section Basic Concepts of Expenses Generally Present in a Physician Practice www.aicpa.org/fvs 21 Physician practices can be categorized as follows: Operating Expenses Variable - Medical supplies - Contracted lab services - Office supplies - Transcription - Marketing & advertising Staff Salaries and Benefits - Salary - Payroll taxes and insurance - Health insurance - 401k and/or profit sharing 22. Forensic and Valuation Services Section Basic Concepts of Expenses Generally Present in a Physician Practice www.aicpa.org/fvs 22 Physician practices can be categorized as follows continued: Equipment leases Equipment Financing (interest expense and depreciation) Provider compensation - Salaries or draws based on corporate structure - Benefits (including pension) - Other expenses (including personal) 23. Forensic and Valuation Services Section Federal Physician Self-Referral Law, aka Stark & Federal Anti Kickback Statute Establish requirements for healthcare transactions which include: Fair Market Value Not based on volume or value of referrals or other business generated between the parties Commercial Reasonableness Applicable Health Care Laws www.aicpa.org/fvs 23 24. Forensic and Valuation Services Section Compensation and Regulatory Issues www.aicpa.org/fvs 24 Post transaction compensation structure factors into the practice valuation. Health systems cannot pay for a revenue stream twice once with the purchase and then on-going in the physician compensation plan Fair market value and commercial reasonableness (addressed earlier) must also be considered with regards to physician compensation 25. Forensic and Valuation Services Section Need for Valuation Services in Healthcare www.aicpa.org/fvs 25 26. Forensic and Valuation Services Section Need for Valuation Services in Healthcare www.aicpa.org/fvs 26 27. Forensic and Valuation Services Section Need for Valuation Services in Healthcare www.aicpa.org/fvs 27 28. Forensic and Valuation Services Section Traditional Needs for Valuation Services in Healthcare 28www.aicpa.org/fvs 29. Forensic and Valuation Services Section Significant Differences from Business Valuations of other In Other Industries www.aicpa.org/fvs 29 Typically, financial statements are going to be on the modified-cash or income-tax basis (non accounts receivable or accounts payable) It can be difficult to obtain an accurate patient accounts receivable aging report The effect of unpaid credit balances on revenues (cash collections) should be considered Medical equipment is typically going to have been depreciated on accelerated tax methods 30. Forensic and Valuation Services Section Physician Practice Valuation Specific Information to Request and Consider www.aicpa.org/fvs 30 Specialties, board certifications, length of time with practice, years to retirement The physicians Is the practice operating at capacity? Office/physician schedule In/out of network (access)? Rates? Managed care contracts Understand the dynamics of historical physician compensation Collections/charges by provider 31. Forensic and Valuation Services Section Physician Practice Valuation Specific Information to Request and Consider www.aicpa.org/fvs 31 Mid-levels? Non-physician, licensed employees? Non-physician employees Collections/charges by payorPayor mix Privileges, call group, medical directorships, etc. Hospital affiliation 32. Forensic and Valuation Services Section Physician Practice Valuation Specific Information to Request and Consider www.aicpa.org/fvs 32 Patients in the practice Zip code reports show the area patients are drawn from Referral reports show how new patients have come into the practice. Other demographics how long have patients been with the practice? How many new/recurring patients are seen? 33. Forensic and Valuation Services Section Physician Practice Valuation Specific Information to Request and Consider www.aicpa.org/fvs 33 CPT/HCPCS code analysis Top 10 codes Technical and professional components of ancillary services 34. Forensic and Valuation Services Section Physician Practice Valuation Specific Information to Request and Consider www.aicpa.org/fvs 34 Data to Request Requested Reports - Broken down by insurer. - One type of insurer can have different plans so it may have more than one amount on the reports. - Do not want any reports with patients names. - HIPAA data security requirements apply to business associates, including appraisers a signed business associate agreement is recommended. 35. Forensic and Valuation Services Section Understanding the Practice www.aicpa.org/fvs 35 The range of services provided by the practice and whether those services are provided at the practice or at a hospital Recent or planned changes in providers Production considerations if the entity has non-physician practitioners (NPPs) understand how they are tracked Are there any planned changes with regards to production? 36. Forensic and Valuation Services Section Understanding the Practice www.aicpa.org/fvs 36 Production Measures Issues to Consider Office Visits Number of patients seen in an ambulatory (office) setting Encounters Can mean ambulatory Procedures Can mean every CPT submitted or the number of times a certain case is performed Cases Often comprised of multiple CPT codes or procedures; assistant surgeon cases may be reflected RVUs / wRVUs Impact of modifiers, multiple procedure discounts 37. Forensic and Valuation Services Section Physician Practice Valuation Drivers www.aicpa.org/fvs 37 The physicians specialty(ies) Possession of state-of-the-art technology and equipment The range of services provided by the practice and whether those services are provided at the practice or at a hospital A staff that is familiar with coding and runs the practice efficiently Effective use of mid-level providers 38. Forensic and Valuation Services Section Physician Comp Benchmark Compensation Data www.aicpa.org/fvs 38 American Medical Group Association (AMGA) Medical Group Compensation and Financial Survey Includes clinical compensation Hospital & Healthcare Compensation Service (HHCS) Physician Salary & Benefits Report Includes clinical and medical director compensation Medical Group Management Association (MGMA) Physician Compensation and Production Survey Includes clinical compensation AMGA HHCS MGMA 39. Forensic and Valuation Services Section Physician Comp Benchmarking Example www.aicpa.org/fvs 39 Allergy/Immunology Compensation Compensation wRVUs Collections Mean $ 287,668 4,438 $ 629,018 25th Percentile $ 198,432 3,438 $ 419,867 Median $ 254,386 4,286 $ 564,312 75th Percentile $ 357,457 5,200 $ 807,602 90th Percentile $ 461,637 6,452 $ 1,042,968 Physician Metrics $ 550,000 4,000 $ 450,000 Benchmarks Mean 47.70% -10.95% -39.78% 25th Percentile 63.92% 14.06% 6.70% Median 53.75% -7.16% -25.40% 75th Percentile 35.01% -29.99% -79.47% 90th Percentile 16.07% -61.30% -131.77% 40. Forensic and Valuation Services Section Benchmarking Example MGMA Data www.aicpa.org/fvs 40 41. Forensic and Valuation Services Section A Sampling of Sources of Information www.aicpa.org/fvs 41 BVR / AHLA Guide to Healthcare Valuation MGMA / AMGA Annual Publications The Healthcare Acquisition Report by Irving Levin Associates Centers for Medicare and Medicaid Services website: www.cms.gov American Health Lawyers Association publications 42. Forensic and Valuation Services Section Use of Cost Approach to Value Health Care Entities www.aicpa.org/fvs 42 Accounts receivable is not on the balance sheet Must understand when and how gross charges are reduced to contractual fee schedule in estimating the value of accounts receivable If significant, consider use of a medical equipment appraiser to determine FMV of medical equipment 43. Forensic and Valuation Services Section Use of Cost Approach to Value Health Care Entities www.aicpa.org/fvs 43 Consider not only the replacement cost, but the economic obsolescence of any intangibles Economic obsolescence relates to the inability of the intangible asset owner/operator to generate a fair rate of return on investment (ROI) (AICPA Forensic and Valuation Services Section, Intangible Asset Valuation: Cost Approach Methods and Procedures, p. 28) Accounts payable and other liabilities are likely not on the balance sheet Note: Case law may dictate the use of the cost approach for purposes of marital dissolution 44. Forensic and Valuation Services Section New Guidance - Cost Approach www.aicpa.org/fvs 44 AICPA FVS section issued a new white paper, Intangible Asset Valuation: Cost Approach Methods and Procedures Common types of health care intangible assets identified include, among others: Medical, dental and other professional licenses Patient relationships Patient files and records (manual and electronic) Electronic medical records computer software Medical and administrative assembled workforce Employment and noncompetition agreements A professionals personal goodwill An entitys institutional goodwill Many others 45. Forensic and Valuation Services Section New Guidance of Cost Approach www.aicpa.org/fvs 45 Continuing debate among healthcare appraisers about the use of the cost approach to establish FMV of intangible assets in physician practices. 46. Forensic and Valuation Services Section Use of Income Approach to Value Health Care Entities www.aicpa.org/fvs 46 Useful to demonstrate the impact of physician compensation Commonly going to see the use of discounted cash flows over the period specified in the employment contract Incorporate post-acquisition physician compensation arrangements 47. Forensic and Valuation Services Section Use of Income Approach to Value Health Care Entities www.aicpa.org/fvs 47 Anticipated reimbursement changes can be modeled in the DCF (advantage over capitalization of earnings Consider payor mix and announced or anticipated changes in fee schedules along with impact on revenue Consider anticipated patient volume trends in conjunction with understanding of the practice and its providers 48. Forensic and Valuation Services Section Income Approach Considerations www.aicpa.org/fvs 48 Other valuation considerations: Ownership of space must be determined to determine fair market value of rent Normalize or project effects of providers recently joining or departing the practice Post-transaction compensation Derby et al v. Commissioner) Additional ancillary services introduced or discontinued Many others 49. Forensic and Valuation Services Section Effect of Physician Compensation on Value www.aicpa.org/fvs 49 Capitalized Value Ongoing Cash Flow to Invested Capital Comp @ 542,000 $26,000 Capitalization Multiple 6.00 Indicated Capitalized Value of Invested Capital 156,000 Less: Interest Bearing Debt 0 Indicated Capitalized Value of Equity $156,000 Capitalized Value Ongoing Cash Flow to Invested Capital Comp @ 200,000 $368,000 Capitalization Multiple 6.00 Indicated Capitalized Value of Invested Capital 2,208,000 Less: Interest Bearing Debt 0 Indicated Capitalized Value of Equity $2,208,000 50. Forensic and Valuation Services Section Use of Market Approach to Value Health Care Entities www.aicpa.org/fvs 50 Thought to potentially include synergies Hypothetical sale of practice may be inconsistent with theories underlying determination of alimony and child support in divorce cases The Goodwill Registry rule of thumb? Useful Information? Quality of transaction data is generally poor and limited in number Almost always an income based or asset based approach to value 51. Forensic and Valuation Services Section Use of Market Approach to Value Health Care Entities www.aicpa.org/fvs 51 In some instances involving health care entities (less likely to be useful in valuing physician practices), information from publicly held companies may be helpful. 52. Forensic and Valuation Services Section Questions www.aicpa.org/fvs 52 53. Forensic and Valuation Services Section For additional information, please visit: AICPA Forensic and Valuation Services (FVS) Section www.aicpa.org/fvs Certified in Financial Forensics (CFF) Credential Overview www.aicpa.org/cff (ABV) Accredited in Business Valuation Credential Overview www.aicpa.org/abv www.aicpa.org/fvs 53 54. Forensic and Valuation Services Section See You at the Event! Visit www.aicpa.org/FVS_CPE_Events to register for the following face-to face educational opportunities: AICPA Fair Value Measurements Workshop September 19-20, 2011 in New York, NY AICPA National Forensic Accounting Conference September 21-23, 2011 in Chicago, IL AICPA National Business Valuation Conference November 6-8, 2011 in Las Vegas, NV www.aicpa.org/fvs 54 55. Forensic and Valuation Services Section FVS Resources AICPA Forensic and Valuation Services www.aicpa.org/fvs FVS Practice Aids and Other Non-authoritative Guidance - (members only) www.aicpa.org/fvspracticeaids FVS CPE & Events www.aicpa.org/fvs_cpe_events www.aicpa.org/fvs 55 56. Thank You! www.aicpa.org/fvs