Healthcare valuation the financial appraisal of enterprises assets and services (two volume set)

When I first began my appraisal education in the late 1970s, the availability of business valuation literature related to the appraisal of closely held enterprises was virtually nonexist

Healthcare Valuation

Volume 1

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Healthcare Valuation

Volume 1

The Four Pillars of Healthcare Value

RoBERT JAMES CiMASi

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Library of Congress Cataloging-in-Publication Data

Cimasi, Robert James.

The four pillars of healthcare value / Robert James Cimasi.

volumes cm.—(Wiley finance series)

includes index.

iSBN 978-1-118-83297-4 (2 vol set)—iSBN 978-1-118-29279-2 (vol 1: cloth)— iSBN 978-1-118-83291-2 (vol 2: cloth)—iSBN 978-1-118-33173-6 (epub)—

iSBN 978-1-118-33402-7 (epdf) 1 Medical care, Cost of—United States

2 Health insurance—United States 3 Health care reform—United States i Title RA410.53.C56 2014

362.10973—dc23

Printed in the United States of America

10 9 8 7 6 5 4 3 2 1

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Foreword xi Preface xiii Acknowledgments xxiii

Disclaimer xxvii

Volume 1

Introduction 1

ChAPter 1:

the Chronology of U.S healthcare Delivery:

technology 531ChAPter 6:

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About the Companion Website 675 Index 677

Appendix: Subject Property Interest 979

Index 1087

This comprehensive book traces the structure and economies of the

healthcare system in the United States from its origins through the present day, as the foundation for the financial appraisal of healthcare enterprises, assets, and services

It is based on exhaustive research and the 20-plus years of experience of Bob Cimasi’s firm, Health Capital Consultants (its library holds over 50,000 books, papers, etc.) The book is heavily documented—the first chapter alone has more than 300 footnotes, and the second, more than 650!

While Bob is one of the most incisive authors covering the healthcare system, he is at the same time one of the system’s harshest critics For exam-ple, he makes reference to “the falling rank of U.S health status as compared

to other developed nations,” and

The last two decades have seen the accelerated transformation of the U.S healthcare professions into a service industry enterprise, whereby health services have been unitized, protocolized, and homogenized,

in order to facilitate their sale in the market, just as if they were any other fungible market commodity, e.g., soybeans and pork bellies.

Note his frequent use of italics for emphasis, so that the reader can almost hear him speaking

His chapter on technology gets into the value drivers of management technology, as well as what we more conventionally think of as scientific technology For example, he offers statistics on the rise in the incidence, complexity, and cost of both Electronic Health Records (EHRs) and the

new version of the International Statistical Classification of Diseases and Related Health Care Problems (ICD) Originally established in 1893, the

ICD is scheduled to implement its tenth revision, ICD-10, in 2014, which will increase the number of procedure codes from 4,000 to 72,000 and diagnostic codes from 14,000 to 69,000

Bob Cimasi introduces a lot of healthcare industry–specific acronyms, (e.g., ACA for Affordable Care Act) and defines each acronym the first time

it is used, but most often not subsequently, so readers need to pay attention

to the sidebars of key terms included in each chapter and the acronyms

appearing at the end of each chapter (as well as the Glossary found in

Vol-ume 2) so that they don’t get lost in the sea of acronyms, which are ingly endemic in healthcare

seem-As a layman with respect to healthcare, I was surprised and impressed with the recent developments in clinical technology, both diagnostic and treat-ment, that Bob summarizes in his extensive chapter on healthcare technology

He liberally sprinkles illustrative tables, charts, and graphs where applicable throughout the text These are often quite helpful to the reader to give more detail or a more lucid feeling for what the text is saying

Prior to the chapters on the valuation of specific types of healthcare entities, there are three excellent general chapters on valuation in Volume 2,

“Basic Valuation Tenets”; “Valuation Approaches and Methods”; and “Costs and Sources of Capital.” These comprehensive chapters delve into more detail than I perceive the average reader may need to know, so I believe that the average reader can skip over some of the more esoteric parts of these chapters without losing the central essence of them, while the more advanced professional may seek to focus on this robust content

The several chapters on the valuation of specific types of healthcare prises, services, and their various tangible and intangible assets demonstrate Bob’s insightful knowledge of the healthcare industry and its components For each major category of enterprises within the healthcare professions, he explains the nature, value drivers, and relevant trends of each subcategory, from hospitals to various types of clinical and nonclinical services

enter-For example, in the chapter on valuing inpatient enterprises, he points out that for hospitals, both capacity and occupancy rates are among the value drivers, and he provides a table of average occupancy rates by own-ership category and size from 1975 through 2009 He gives a useful chart

of other variables to consider and another convenient chart of sources of benchmarking data for these variables

Readers should not delude themselves into believing that they will become instant experts in healthcare valuation This is not a “how to” book However, it provides both breadth and depth of detailed understanding into many specialties within the healthcare field, for both facilities and services

At this time of the greatest evolution in the history of healthcare valuation,

it provides both exhaustively researched information and keen insight into value drivers and trends in most aspects of the healthcare field It is a monu-mental contribution to the literature about the valuation of the healthcare industry and the medical profession

Shannon Pratt, CFA, FASA, MCBA, ARM, ABAR

Shannon Pratt Valuations, Inc

Portland, Oregonshannon@shannonpratt.com

The great thing in this world is not so much where we stand, as in what direction we are moving.

—Oliver Wendell Holmes

This year marks my thirtieth as a healthcare appraiser and the twentieth

anniversary of Health Capital Consultants (HCC), the consulting firm I started in 1993 During that period, I’ve witnessed and experienced unprec-edented change in both the healthcare industry and the valuation profes-sion, as described in the following sections

The Changing healThCare indusTry Paradigm:

The CorPoraTizaTion of mediCine

The corporatization of medicine and the rise of for-profit healthcare have replaced the cottage industry of Marcus Welby–physician practices and the

small community hospitals that were prevalent at the start of my career The last three decades have seen the accelerated transformation of the medical

professions into U.S healthcare service industry enterprises, whereby care services have been unitized, protocolized, and homogenized, in order

health-to facilitate their sale in the market, just as if they were any other fungible

market commodity, little differentiated from soybeans and pork bellies This

new healthcare delivery paradigm has accelerated alongside the tion of medicine, as demonstrated by the increase in large hospital systems;

corporatiza-the retreat from private practice of medicine to employed physicians; and the consolidation of payors by large, for-profit health insurance firms

Changes in The enTerPrises, asseTs, and serviCes

subjeCT To aPPraisal and sCoPe of engagemenT

This changing paradigm has resulted in an evolving array in the types of

enterprises, assets, and services that are subject to being appraised As

the complexities associated with healthcare transactions have increased

significantly, there has been a simultaneous increase in the opportunities available for the business valuation profession in scope and diversity arising

from the growing demand for analysis related to both Fair Market Value and commercial reasonableness opinions for pending transactions There

will inevitably be fewer engagements focused on appraising solo and small group medical practices, as the healthcare industry consolidates, and greater numbers of physicians and other providers form larger organizations based

on new emerging models of organizing the delivery of care

These emerging healthcare organizations (EHOs) will continue to be

driven by the need to develop new affiliations, capital structures, and ernance configurations, in order to align the interests of patients/ consumers

gov-with the various U.S healthcare industry subsectors, including inpatient and outpatient providers; payors and managed care entities; and suppliers and vendors, in such a manner as to address the emergence of value-based reim- bursement initiatives focused on both lowering costs and improving quality

These factors have necessarily also changed the scope of appraisal ments, with an increasing volume of appraisals focused on property interests

assign-other than at the total enterprise level, and more emphasis on discrete erty interests and services, as well as more focused attention on the highest and best use concept and the selection of the appropriate premise of value, that is, either value in-use as a going concern or value in-exchange Given

prop-these complexities, the opportunities for additional collaboration among the various appraisal disciplines, such as business valuation, intangible assets and intellectual property, real estate, and machinery and equipment and personal property, have never been greater

CaPiTal markeT Changes: availabiliTy of CaPiTal and

new finanCial insTrumenTs

Changes in the capital markets related to both the availability of capital sources and the types of financial instruments used in financing healthcare transactions, particularly in recent years following the Great Recession, have transformed the way that healthcare providers, as well as the healthcare transactional marketplace, operate.1 Neither healthcare enterprises nor the

capital markets in which they operate, exist within a vacuum Wide-ranging factors have an impact on the global and national economy and reverberate through markets, affecting the functioning of capital markets in healthcare,

years following the collapse of the capital markets from 2007 through 2009.

as well as in other industries The effects of the economic downturn of the

Great Recession included a dramatic retraction in the availability of capital,

as well as the imposition of strict lending conditions on those few credits that

were being granted, even for stable and profitable healthcare enterprises.2

Changes in The valuaTion liTeraTure and eduCaTion

The valuation profession has also progressed significantly during the last three decades When I first began my appraisal education in the late 1970s, the availability of business valuation literature related to the appraisal of closely held enterprises was virtually nonexistent, with only a few seminal

interdisciplinary valuation works, for example, Taussig’s Principles of nomics (1918), Bonbright’s The Valuation of Property (1937), and Babcock’s Appraisal Principles and Procedures (1968), with most other authoritative

Eco-texts relating only to real estate appraisal and corporate finance.3 However, starting in the 1970s, several books began to address (albeit slowly) the appraisal of other closely held businesses and business interests.4 During the next two decades, several additional texts related to appraising closely held business enterprises were published, including:

Richard Rickert.5

Jour-nal, September 2, 2011, http://online.wsj.com/article/SB1000142405311190419940

4576536930606933332.html (accessed April 26, 2012).

Bonbright, The Valuation of Property (New York: McGraw-Hill Book Company, 1937); Henry A Babcock, Appraisal Principles and Procedures (Washington, DC:

American Society of Appraisers, 1989).

& Sons, in 1971, devoted just four pages to valuing professional practices and services companies

Miles (Englewood Cliffs, NJ: Institute for Business Planning, 1977); Shannon P

Pratt, DBA, CFA, CFP, ASA, Valuing a Business (Homewood, IL: Dow Jones-Irwin, 1981); Raymond C Miles, Basic Business Appraisal (New York: John Wiley & Sons, 1984); Richard Rickert, Appraisal and Valuation: An Interdisciplinary Approach

(Washington, DC: American Society of Appraisers, 1987).

Beginning in the 1980s, the cannon of professional valuation literature related to appraising professional practices, including medical practices, began to emerge, including such titles as:

Pratt;

Arrangements by James Jackson and Roger Hill;

Unland;

Since that time, there has been a flurry of books and peer-reviewed nal articles, as well as academic research sources and industry newsletters, related to the various aspects of financial valuation, including the applica-

jour-tion of cost of capital, tax affecting, and discounts for lack of marketability

to the valuation of closely held businesses and professional practices Today, there are now excellent treatises and other authoritative texts and sources related to those aspects of financial valuation, as well as benchmarking and forecasting in both the transactional and litigation support arenas

While healthcare financial appraisal literature has grown exponentially

in the last 10 years, its very availability and the volume of information present a challenge to all professional consultants working at the forefront

of this competitive healthcare industry Simply stated, how do we find the

Press, 1980); Valuing a Medical Practice (Monroe, WI: American Medical tion, 1981); Shannon Pratt, DBA, CFA, CFP, ASA, Valuing Small Businesses and Pro-

Associa-fessional Practices (Homewood, IL: Dow Jones-Irwin, 1986); James B Jackson and

Roger K Hill, New Trends in Dental Practice Valuation and Associateship

Arrange-ments (Chicago: Quintessence Publishing, 1987); Madeleine Pelner Cosman, Selling the Medical Practice (Tenafly, NJ: Bard Hall Press, 1988); James J Unland, Under- standing the Valuation of Medical Practices (Chicago: Health Capital Group, 1989);

James L Horvath, Ca, CBV, ASA, CCH, Valuing Professional Practices (Canadian Limited, 1990); Linda G Ginsburg, Financial Valuation of Your Practice (Los

Angeles: Practice Management Information Corporation, 1991).

time to sort through an accelerating ocean of information and data, select what is relevant, analyze it, and report it to our clients in a comprehensible, timely, and cost-effective manner? I addressed these challenges in my career

by making a commitment to act on behalf of those providers who lacked the resources to adapt to change quickly enough to effectively compete in today’s intensely competitive and dynamically turbulent market Toward that end, the development of a disciplined healthcare finance and economics research staff and library resource was established as the focus of the core services that HCC delivers to its clients

Change in valuaTion Profession sTandards

Valuation standards and codes of ethics have also evolved during the last 30 years, concurrent with the development of professional business valuation designations by the American Society of Appraisers, the Institute of Business Appraisers, the National Association of Certified Valuators and Analysts, and the American Institute of Certified Public Accountants The emergence

of these various groups in promulgating standards has sometimes presented the appraisal community with conflicting valuation standards—perhaps due, in part, to changes in accounting concepts and procedures, for exam-ple, International Financial Reporting Standards (IFRS) versus Financial Accounting Standards Board (FASB) pronouncements

More recently, the International Valuation Standards Council (IVSC) and other groups, building on the previous efforts of CLARENCE to develop the international glossary of business valuation terms, and the National

Association Business Valuation Standards Council, which attempted to monize the standards of various appraisal organizations, have made efforts

har-to consolidate professional standards The issuance of judicial gatekeeping

authority regarding expert witness testimony emanating from Daubert v Merrell Dow Pharmaceuticals, Inc., decided by the U.S Supreme Court in

1993, superseded the Frye (1923) standard in federal courts regarding the admissibility of scientific expert testimony, and in 1999, the Kumho Tire v Carmichael case held that Daubert’s factors should be extended to apply

to nonscientific expert testimony, thereby setting additional thresholds and

standards for appraisers.7

U.S 579 (1993); Kumho Tire v Carmichael, 526 U.S 137 (1999).

Changes in regulaTory sCruTiny

During the last several years, there has been intensifying regulatory scrutiny related to the healthcare transactional marketplace regarding the potential for

Anti-kickback, Stark, and other fraud and abuse violations involving

Medi-care and other government payors Initiatives such as the Fraud Enforcement and Recovery Act (FERA), the Healthcare Fraud Prevention and Enforce-ment Action Team (HEAT), and the Medicare Fraud Strike Force have only been intensified with the passage of the 2010 Patient Protection and Afford-able Care Act (ACA) A significant portion of this regulatory scrutiny has

focused on the issues of Fair Market Value and commercial reasonableness

related to the consideration being paid in transactions between tax-exempt hospital organizations to for-profit physician groups as part of the massive consolidation and integration initiatives currently being undertaken

There has also been heightened regulatory scrutiny and the potential for severe penalties aimed at appraisers under Section 6695A of the Pension Protection and Affordable Care Act of 2006 for “substantial and gross valu-ation misstatements attributable to incorrect appraisals” that were “pre-pared by a person who prepared an appraisal of the value of property and who knew, or should reasonably have known, the appraisal would be used

in connection with a return or claim for refund.”8

Changes in ClienT exPeCTaTions

Client expectations have also evolved, particularly as a result of cal advancements that have transformed the manner by which we communi-cate with our clients The days of hanging wet copy fax pages on a clothesline

technologi-to dry and using a 56K dial-up modem have been replaced with cell phones,

e-mail, instant messaging, video teleconferencing, and secure back offices and data rooms Each of these advances has come with an accompanying

rise in client expectations and demands for access to appraisers, as well

as a rise in the requirement for appraisers to be instantaneously accessible throughout the engagement The way in which our financial models are developed and prepared has also evolved, largely due to the accessibility

cor-rect (income tax); or the value is 65 percent or less than the amount determined to

be correct (estate or gift tax) Gross value is 200 percent or more than the amount determined to be correct (income tax); or the value is 40 percent or less than the amount determined to be correct “Substantial and gross valuation misstatements attributable to incorrect appraisals,” Internal Revenue Code, 26 USC § 6695A.

of available data sources required for due diligence (particularly prevalent

in the healthcare arena) that we receive electronically through databases and other data portals, as well as the exponential growth in the availability

of healthcare financial and economic literature, and the input of academic theory, especially during the last 10 years

healThCare indusTry sPeCializaTion

While the subject of industry specialization has been a point of contention for many years, in 1999, Chris Mercer (a valuation thought leader whom I greatly admire and respect), stated the issue succinctly as, “The basic ques-

tion often boils down to: Should we hire an industry expert for this ment, or is it preferable to hire a valuation professional?” Chris commented

engage-that “I believe I can say, based on many years of valuation experience, engage-that

valuation expertise combined with a broad base of industry experience, is

a preferable experience set than purely industry expertise.”9 Based on my more than 30 years of healthcare valuation experience, I believe I can say that I both agree (in part) and disagree (in part) with Chris’s comment

I hold both valuation “generalists” and healthcare “industry specialists”

in high regard; each group has contributed enormously to the advancement

of the valuation profession I would certainly agree that a strong base of general business knowledge and experience, as well as a thorough educa-tion in economic and financial principles, basic valuation tenets, appraisal methodology, and professional standards, are prerequisites to a successful appraisal engagement However, given the complexities associated with understanding the value drivers that are often unique to the healthcare industry, the explosion of information and data available to appraisers, the heightened regulatory scrutiny, and the volatile dynamics of the new para-digm of healthcare reform, the valuation profession has necessarily evolved toward industry specialization This is generally the result of the recogni-tion that to be credible in performing a healthcare valuation, the appraiser also needs to possess an in-depth, informed understanding of the esoteric and complex attributes of the healthcare industry, which often appears to operate under a disparate, seemingly counterintuitive, framework of market economics (e.g., demand-driven, inelastic pricing)

The in-depth, robust knowledge required of a healthcare appraiser often can begin with a background of healthcare industry expertise, such

Expert,’” E-Law Business Valuation Perspective Newsletter, 1999-17 (December 15,

1999)

as in hospital financial management, but that experience alone is not ficient without a thorough valuation education Furthermore, credibility as

suf-an appraiser of healthcare interests requires a continuing commitment to keep abreast of the almost daily changes in national and regional economic conditions impacting the healthcare industry; payment and reform initia-tives, reimbursement trends, regulatory and enforcement trends, the payor/delivery system mix, healthcare manpower and labor practices, supply-side dynamics, capital costs, emerging and declining models of health-care organizations, and other issues related to the healthcare industry and transactional markets For those valuation professionals who lack specific healthcare industry expertise, there has never been greater access to data and information related to the economic financial, and transactional areas

of healthcare Also, there is an increasing availability for both valuation education and professional development, as well as for obtaining a compre-hensive understanding of the healthcare arena through healthcare associa-tions and medical societies; online newsletters, journals, and health law and policy reporters; academic curricula; and courses, conferences, workshops, and symposiums, many of which are available through distance education, for example, audio conferences webinars

There has long been a discernible pattern of consensus among healthcare industry clients to engage healthcare valuation specialists, at least for proj-ects of any size or complexity Recently, there also appears to be a growing acknowledgment in the valuation profession that industry specialization, in this case, with a professional focus on research and training specific to the healthcare industry, is warranted Toward that end, on January 28, 2012, the Board of Governors of the American Society of Appraisers (ASA), “the oldest and only major appraisal organization representing all of the disci-plines of appraisal specialists,” passed a resolution establishing the “ASA Advanced Multidisciplinary Education in Healthcare Valuation” program

as developed by the ASA Healthcare Special Interest Group (ASA HSIG) educational subcommittee.10

why i wroTe This book

The healthcare industry is a vast and diverse part of the American economy that is undergoing a sustained and dramatic transformation While the ulti-mate course that U.S healthcare reform initiatives will follow is uncertain,

AboutUs.aspx (accessed April 22, 2013).

and there is still a quandary of unresolved issues posed by this perfect storm, one thing I know for certain is that whether one views it as a bless-

ing or a curse, it is undeniable that there will be exponential growth in the demand for healthcare valuation professional services, and that the financial appraisal of healthcare enterprises, assets, and services will continue to grow

in scope and complexity.11

In writing Healthcare Valuation, I focused, first and foremost, on the

historical development of the U.S healthcare industry and medical fession and the broad underlying market conditions and trends in which healthcare transactions and litigation take place, as well as the related basic tenets of financial economics in regard to the approaches and methods of healthcare valuation The objective of this text is to gather and present the technical aspects of business valuation methodology relative to the financial appraisal of emerging healthcare organizations, within the context of the

pro-Four Pillars of the healthcare industry, that is, reimbursement, regulatory, competition, and technology

This book is intended to supplement, not supplant, the existing cannon

of professional valuation literature and builds on a solid foundation of authoritative texts, treatises, and research by professionals who have contributed greatly to that literature, as well as to the development of the business valuation profession, many of whom I am proud to call my friends and colleagues of many years and gratefully acknowledge as mentors It is

my hope that this book will augment what they have previously contributed

Robert James Cimasi, MHA, ASA, FRICS, MCBA, AVA, CM&AA

Health Capital ConsultantsSaint Louis, Missouri

March 2013

The assistance and support of a number of my Health Capital Consultants

(HCC) colleagues were instrumental to the development and publication

of this book

Todd A Zigrang, MBA, MHA, FACHE, ASA, HCC President, and Anne

P Sharamitaro, Esq., HCC Executive Vice President and General sel, were central to the development of this project and greatly assisted by contributing to this work

Coun-Other HCC colleagues who contributed significantly to this book include Vice President Matthew J Wagner, MBA; Vice President John R Chwarzinski, MSF, MAE; Senior Financial Analyst Jonathan T Wixom; and Senior Financial Analyst Grant D Heggie, MBA, MHA

In addition, HCC’s research and library staff, as well as members of HCC’s consulting and administrative support team, were of great help.Also, many thanks to our professional colleagues and clients who served as reviewers of, and commentators on, the various drafts of this work along the way, including Dr Shannon Pratt, CFA, FASA, MCBA, ARM, ABAR, for his encouragement and inspiration over many years, as well as his comments on this text and his contribution of the Foreword; David Grauer, Esq., of Squire Sanders, LLP; Bob Morrison, ASA, BV/IA; Robert Schlegel, ASA, CBA, CCP, CDP, CISA, CSP; Richard M Wise, FASA, MCBA, FCBV, FRICS, CVA, FCA, CPA, CA; Chris M Mellen, ASA, MCBA, CVA, ABAR, CM&AA, MBA; Michael Gregory, ASA, AVA, PE; James B Lurie, ASA, CBA, CVA, BVAL; Howard Lewis, MS, GVA, AVA; Robert L Wilson, Jr Esq.; Lari B Masten, MSA, CPA, ABV, CFF, CVA, ABAR; John Paglia, PhD, MBA; Dick Thorsen, CPA, CMEA, CVA; Morton Cohen, CPA; and, Tim Alexander, MLS, for their helpful review and commentary

as Chief Executive Officer of Health Capital Consultants (HCC), a nationally recognized healthcare financial and economic consulting firm headquartered in St Louis, Missouri, serving clients in 49 states since 1993

Mr Cimasi has more than 30 years of experience in serving clients, with

a professional focus on the financial and economic aspects of healthcare service sector entities, including valuation consulting and capital formation services; healthcare industry transactions, including joint ventures, mergers, acquisitions, and divestitures; litigation support and expert testimony; and certificate-of-need and other regulatory and policy planning consulting

Mr Cimasi holds a Masters in Health Administration from the University

of Maryland, as well as several professional designations: Accredited Senior Appraiser (ASA—American Society of Appraisers); Fellow—Royal Institute of Chartered Surveyors (FRICS—Royal Institute of Chartered Surveyors); Master Certified Business Appraiser (MCBA—Institute of Business Appraisers); Accred-ited Valuation Analyst (AVA—National Association of Certified Valuators and Analysts); and Certified Merger & Acquisition Advisor (CM&AA—Alliance

of Merger & Acquisition Advisors) He has served as an expert witness on cases in numerous courts and has provided testimony before federal and state legislative committees He is a nationally known speaker on healthcare industry

topics and the author of several books, the latest of which include Accountable Care Organizations: Value Metrics and Capital Formation (Taylor & Francis,

a division of CRC Press, 2013), The Adviser’s Guide to Healthcare—Vols I, II, and III (2010—AICPA), and The U.S Healthcare Certificate of Need Source- book (2005—Beard Books) Mr Cimasi is the author of numerous additional

chapters in anthologies, books, and legal treatises, published articles in reviewed and industry trade journals, and research papers and case studies, and

peer-he is often quoted by tpeer-he peer-healthcare industry press In 2006, Mr Cimasi was honored with the prestigious “Shannon Pratt Award in Business Valuation,” conferred by the Institute of Business Appraisers Mr Cimasi serves on the Editorial Board of the Business Appraisals Practice of the Institute of Business Appraisers, of which he is a member of the College of Fellows In 2011, he was named a Fellow of the Royal Institution of Chartered Surveyors (RICS)

This work includes information regarding the basic characteristics of

various statutes, regulations, and case law related to the healthcare industry It is intended to provide only a general overview of these topics This information is provided with the understanding that the author and the publisher are not rendering legal or tax advice and services The author has made every attempt to verify the completeness and accuracy of the information; however, neither the author nor the publisher can guar-antee, in any way whatsoever, the applicability of the information found herein Furthermore, this work is not intended as legal or tax advice or as a substitute for appropriate legal counsel

Whereof what’s past is prologue; what to come, in yours and my discharge.

—William Shakespeare, The Tempest, Act 2, scene

It may be the “perfect storm.” The continued rise in healthcare expenditures,

the increasing segment of the U.S population that is uninsured or insured, the growth in demand for care from the changing patient demo-graphic of the aging baby-boomer population, and declining reimbursement for physician services and provider manpower shortages are just a few of the

under-several catalysts that are driving the turbulent transactional marketplace for healthcare enterprises, assets, and services in this new era of reform.

Those valuation analysts, whose healthcare engagements have been

focused on appraising historically traditional provider organizations, for

example, physicians in solo and small group practices, are seeing a decline in their client base as the healthcare industry consolidates, and greater numbers

of providers form new and larger emerging healthcare organizations (EHOs)

These EHOs are driven by the need to develop new affiliations, capital tures, and governance configurations, in order to align the interests of patients/consumers, as well as various U.S healthcare industry subsectors, including

struc-inpatient and outpatient providers, suppliers and vendors, payors, and aged care entities, in such a manner as to address the emergence of value- based reimbursement initiatives, such as Accountable Care Organizations.

man-This book will address the key issues that the professional appraiser should consider when undertaking a healthcare valuation assignment, set within the

conceptual construct of the “Four Pillars” of the U.S healthcare delivery system.

The Four PIllars oF The healThcare IndusTry

In developing an understanding of the forces and the stakeholders that have

the potential to drive healthcare markets, it is useful to examine what value

may be attributable to healthcare enterprises, assets, and services as they

relate to the four paramount market influences of the healthcare

indus-try, that is, the Four Pillars—reimbursement, regulatory, competition, and technology These four elements of the healthcare industry marketplace shape

the dynamic by which providers and enterprises operate within the current transactional environment, while also serving as a conceptual framework

for analyzing the viability, the efficiency, the efficacy, and, ultimately, the value that may be attributed to property interests, whether enterprises, assets, or services Each of these Four Pillars, depicted in Exhibit I.1, will be

further addressed in subsequent chapters

sTrucTure oF ThIs TexT

This text is meant to serve as both a resource and a reference and is focused

on providing guidance in an era of reform related to the requisite research and analytical processes for both (1) the development of a supportable and replicable valuation conclusion and opinion in the financial appraisal of healthcare enterprises, assets, and services; and (2) the submission of a cer-tified valuation report that is both comprehensive and credible It is writ-ten for readers with a wide range of experience and professional focus, including healthcare industry C-suite executives; physicians and other clinical providers and their professional advisers, including attorneys, accountants, and consultants; banking, investment, and transactional advi-sors; and academics, researchers, and students, as well as other interested stakeholders

exhIbIT I.1 The Four Pillars of the Healthcare Industry

This book is structured in two parts:

1 Volume 1 consists of six chapters, beginning with a chronology of the

U.S healthcare delivery system, from the origins of medicine to the transformation of modern healthcare in the twentieth and twenty-first

centuries (Chapter 1) Chapters 2 through 5 explore the paramount influences of the Four Pillars, that is, reimbursement, regulatory, com- petition, and technology, as they apply to healthcare enterprises, assets, and services Chapter 6 provides an overview of the current healthcare

environment in this new era of healthcare reform

2 Volume 2 consists of ten chapters, of which the first four provide a

discussion of basic valuation tenets (Chapter 7), as well as a tation of the generally accepted valuation approaches, methods, and techniques (Chapter  8), and the costs/sources of capital (Chapter 9),

presen-as these topics may be pertinent to healthcare valuation Chapter 10 sets forth the planning and process elements related to a healthcare

valuation engagement The next five chapters examine the following:

the value drivers unique to each type of healthcare enterprise, asset, or service, as well as appropriate valuation approaches, methodologies, and techniques applicable to inpatient enterprises (Chapter 11), outpa- tient and ambulatory enterprises (Chapter 12), other healthcare-related enterprises (Chapter 13), tangible and intangible assets (Chapter 14), and healthcare services (Chapter 15) Finally, Chapter 16 provides the

background and methodology regarding the regulatory threshold of

Commercial Reasonableness.

reader Tools

This book will likely be used intermittently as a resource and a reference,

in contrast to being read “cover to cover” in one sitting Accordingly, to

enhance the utility of this text as a navigable source for readers of

vari-ous backgrounds, certain tools have been developed and appear

through-out the text, including the following categories: Key Concepts, Key Terms, Acronyms, Key Sources, and Factoids Key Concepts are the important con- cepts mentioned in the text that are significant to the healthcare valuation analysis As an acknowledgment, key concepts are italicized in the text for emphasis and contrast Key Terms, also italicized, refer to those significant

words appearing in the text that may need to be defined for the reader and

serve as a subset of the comprehensive Glossary that appears in Volume 2 Acronyms, formed by combining the initial letters or parts of a series of

words, are particularly prevalent in (and often the favorite pastime of) the healthcare industry and appear at the end of each chapter, as well as being

included as part of the Glossary Key Sources point to significant sources

of data and information that are fundamental to the chapter content and

serve as a subset of the comprehensive Bibliography, which is included in Volume  2 Factoids are brief, related facts of interest that are mentioned

within the  text Also included are some concluding remarks and a brief epilogue

A bedrock principle of financial valuation is that economic value is the expectation of future economic benefit to be derived from the ownership

or control of property The valuation analyst should, in keeping with the concept of the principle of induction, begin his forecast of the future with

an in-depth understanding of the past, including the historical development

of the U.S healthcare delivery system within the context of the Four Pillars, the changing reimbursement, regulatory, competitive, and technological

backdrop of an array of volatile, often complex market forces that make

up the “perfect storm” within which the current U.S healthcare

transac-tional marketplace exists.1 The first chapter of this text, “The Chronology

of U.S Healthcare Delivery: From Caduceus to Corporatization,” begins

the journey toward understanding the financial appraisal of healthcare enterprises, assets, and services in the era of reform.

“Valuation Approaches and Methods.”

1

the Chronology of U.S healthcare Delivery: From Caduceus to Corporatization

1.1 Foundation of U.S Healthcare 6

1.1.1 Origins of Medicine 7

1.1.2 Professional Practice and

Status of the Physician 10

1.1.3 Rise of the Medical

University 13

1.1.4 Eastern Medical

Traditions 14

1.1.5 Renaissance: Revival of

Anatomy and Physiology 16

1.1.6 Seventeenth Century: The

Dawn of Scientific Liberty 17

1.1.7 Eighteenth Century: The

Shift Toward the “Science” of

Medicine 21

1.1.8 Nineteenth Century: The Rise

of “the Practice of Medicine”

in the United States 22

1.4.1 Creation of Medicare 44 1.4.2 Creation of Medicaid 46 1.5 1970s 47

1.5.1 Anti-Kickback Statute 47 1.5.2 Rising Costs of Healthcare 47 1.5.3 Attempted Healthcare Reform 49 1.5.4 Health Maintenance Organization Act of 1973 49 1.6 1980s 51

1.6.1 The Graduate Medical Education National Advisory Committee (GMENAC) 51 1.6.2 Passage of the Omnibus Budget Reconciliation Act (OBRA) 53 1.6.3 Passage of Emergency Medical Treatment and Active Labor Act (EMTALA) 54 1.6.4 Development of Diagnosis Related Group (DRG) 54 1.6.5 Development of Prospective Payment Systems 55 1.6.6 Development of Resource- Based Relative Value System (RBRVS) 56

1.6.7 General Counsel

Memorandum #39498 60

1.6.8 Medicare and Medicaid Patient

and Program Protection Act 60

1.6.9 Ethics in Patient Referral Act

of 2003 72 1.8.4 Deficit Reduction Act of

2005 73 1.8.5 Health Opportunity Patient Empowerment Act of

2006 74 1.8.6 Stark IV 74 1.8.7 American Reinvestment and Recovery Act of 2009 74 1.8.8 Fraud and Abuse Initiatives

of 2009 75 1.8.9 Patient Protection and Affordable Care Act (ACA) 76 1.8.10 Health Care and Education Reconciliation Act of 2010 76 1.9 ACA Constitutionality Challenged 77 1.10 Conclusion 79 1.11 Key Sources 80 1.12 Acronyms 81

1.1 FoUnDation oF U.S healthCare

Although the June 2012 decision by the Supreme Court of the United States (SCOTUS) to uphold the 2010 Patient Protection and Affordable Care Act (ACA) was one of the most anticipated rulings, for one of the most factious political debates in U.S history, healthcare reform (in some guise) has been occurring in the U.S healthcare delivery system for more than a century, as the manifestation of continuing evolution and change

The foundation of the U.S healthcare delivery system can be viewed as

the product of (1) the evolution of medical thought and practice; and (2) the evolution of philosophic thought throughout many centuries Paul Starr addresses this evolution in his book The Social Transformation of American Medicine, to wit: “first, the rise of professional sovereignty; and second,

the transformation of medicine into an industry and the growing, though

still unsettled, role of corporations and the state.”1 This chapter addresses the chronological progression of medicine in accordance with this bimodal transformation, as related to the progress of the healthcare practitioner and professional practice credibility.

Medical historian Richard Harrison Shryock further assessed the torical context of medicine, noting:

his-Because it deals with the vital interests of both individuals and societies—with life and death, and with so much that matters in between—medicine has long had an unusually complex and intimate relationship to social and cultural developments at large In other words, medical history involves social and economic as well as biologic content and presents one of the central themes in human experience After all, what is more basic in the life of any people than life itself?

—Richard Harrison Shryock, 19662

An understanding of the chronology of both medical thought and events provides insight into the current state of healthcare delivery in the United States and shapes the trends that may affect those market factors, including valuation, that define the financial aspects of the healthcare industry

1.1.1 origins of Medicine

The origin of the evolution of the practice of medicine and the delivery of healthcare services can be traced to the earliest civilizations located in the Mediterranean region, which saw illness as a curse or a punishment from

the gods that could befall sinners, their families, or their descendants.3 The

abstract notion of medicine was intertwined with religious concepts within

Babylonian, Greek, and Roman cultures Each of these groups depicts its respective god of healing as a figure holding a snake-coiled staff, and this

symbol (often referred to as a Caduceus) is still widely used today to

repre-sent medicine.4 An image of the Greek Caduceus is provided in Exhibit 1.1

writ-ings on the development of American medicine Paul Starr, The Social

Transforma-tion of American Medicine: The Rise of a Sovereign Profession and the Making of a Vast Industry (New York: Basic Books Inc., 1982), p ix.

Johns Hopkins Press, 1966), p xiii.

York: Harry N Abrams, 1978), p 59.

One Snake Is More Than Two,” Annals of Internal Medicine 138, no 8 (April 15, 2003).

Double serpent winding around a staff; a symbol for medicine.

“The Symbol of Modern Medicine: Why One Snake Is More Than Two,” by Robert A Wilcox and Emma M Whitham, Annals of Internal Medicine, 138,

no 8 (April 15, 2003).

exhibit 1.1 Image of the Greek Caduceus

“Greek Caduceus,” detail from t.p of Marco Amelio Severino Viper Pythia (Patavii: Typis

Pauli Frambotti, 1651), from the U.S National Library of Medicine.

Greek medicine continued in this tradition (which was thought to have its origin in Egyptian medical practices and efforts toward hygiene) but began to diverge from its religious foundations to include ethical principles Toward the end of the fifth century, Greek medicine included three elements: (1) the generally discarded religious element; (2) the strong philosophical element; and (3) a rational element relying on observation and accumulated experience.5 Hippocrates, born in Greece in 460 BC, was both a priestly

Factoid

Sumerian, Assyrian, and Babylonian civilizations studied Astronomy intently, and medical concepts developed as a result of the assumed relationships between physiology and celestial findings

A History of Medicine, by Arturo Castiglioni (New York: Alfred A Knopf,

1947), pp 31–44.

Factoid

Hippocrates served as both a priestly and empirical authority of cine during the golden age of Greece, responsible for compiling the Oath of Hippocrates as well as other works

medi-“Antiquity,” in The Greatest Benefit to Mankind: A Medical History of

Human-ity, by Roy Porter (New York: HarperCollins, 1997), p 56; A History of Medicine by Arturo Castiglioni (New York: Alfred A Knopf, 1947), pp 148–49.

aSSyro-babylonian MeDiCine

A systematic medical concept established in the fourth millennia B.C

by the people of Southern Mesopotamia, under which medicine was regarded as an abstraction and was treated with priestly reverence

“Antiquity,” in The Greatest Benefit to Mankind: A Medical History of

Human-ity, by Roy Porter (New York: HarperCollins, 1997), pp 46–47; A History of Medicine by Arturo Castiglioni (New York: Alfred A Knopf, 1947), p 32.

Press, 1923), p xiv.

and an empirical authority of medicine and was often recognized, in

West-ern culture, as the father of medicine.6 He wrote several ethical texts, the

first of which was the Oath of Hippocrates Castiglioni’s book A History of Medicine describes the importance of this oath as covering “the duty of the

physician to his teacher, his pupils, and his patients, [and] clearly shows that

a relationship existed between Hippocratic medicine and priestly medicine; but it raises medicine to a height and human dignity that assures it its own position as a science.”7 Today, medical students still commonly take the Hip-pocratic Oath as a commitment to uphold ethical standards in their practice

of medicine.8

1.1.2 professional practice and Status of the physician

Initially, Greek physicians practicing in Rome were looked down on and regarded with little, if any, respect.9 Many people at the time adopted the

title of physician without any significant or standardized training,

contribut-ing to the defamation of the profession.10 However, in 46 BC, Julius Caesar

granted physicians the right to Roman citizenship, an honor that elevated the reputation of physicians.11 Soon thereafter, laws requiring the train-ing, certification, and control of physicians were established in an effort to

repel the invasion of unqualified healers looking for easy profit in Rome.12

The skill of these professionals also improved as the number of medical

schools approved by the Roman Empire increased, the most celebrated of which could be found outside of Italy, in France (Marseille and Lyon), Spain

2007), p 93.

his-torian who taught the History of Medicine at Yale University Jerome P Webster,

“Arturo Castiglioni, M.D.: 1874–1953,” Bulletin of the New York Academy of

Med-icine 29, no 5 (1953): 438–439; Arturo Castiglioni, A History of MedMed-icine, 2nd ed

(New York: Alfred A Knopf, 1947), p 177.

York: Harry N Abrams, 1978), p 231.