Practice Management and Economics

A Winning Cath Lab Financial Strategy: Why Build Your Own Cath Lab When You Can Lease it?

Don Barbo, CPA/ABV, MBA
Don Barbo, CPA/ABV, MBA
Owners and physician/users of cardiac catheterization labs (cath labs) may be missing out on an opportunity to increase their respective cash flows and to further enhance their business relationships with each other. The use of lease agreements and purchased services agreements can provide the mechanisms to enhance revenues, more fully utilize facility resources, prevent the loss of cardiac care patients to competing facilities, and avoid costly and duplicate capital outlays. How can Lease Agreements and Purchased Services Agreements Benefit us? As Medicare and managed care payors continue to exert significant pricing pressures on physician professional fees, combined with inflationary increases in operating expenses, physicians face the prospect of working harder but earning less. Based on published survey data for cardiology practices, the median net revenue per patient encounter for cardiology physicians increased from $114 in 1996 to $121 in 2000 (increasing at a rate of approximately 1.5% compounded annually), while the median operating expense per patient encounter increased at a rate 3.5 times as fast from $44 to $54 (increasing at a rate of approximately 5.3% compounded annually) over the same period.1 In an effort to offset this erosion of net earnings, cardiologists may be tempted to develop their own cath labs and capture the technical fee revenue stream that typically flows to hospitals. However, before committing the substantial capital investment in taking on the significant business and financial risks involved in developing a cath lab, physicians should first consider a less risky alternative approach. Lease agreements and purchased services agreements (PSAs) can allow physicians to tap into additional revenue sources without requiring the capital investment of building a new facility. Hospitals, in choosing to lease their cath lab facilities, can benefit from this financial strategy to better utilize its cath lab resources (including leasing the facility during extended hours and weekends or during other low volume periods) while creating a fixed and reliable rental revenue stream to counteract unpredictable patient volumes and negative reimbursement pressures. Additionally, leasing and PSA arrangements, if properly structured, can strengthen and enhance relationships between facility providers and physician-users by matching available resources (i.e., cath lab facility, equipment, trained and assembled employees, etc.) with the physician demand for these resources on a “turn key” basis. These enhanced relationships can result in fewer lost cardiac cases to competing facilities. How Do These Arrangements Work? Leasing arrangements. Under a leasing arrangement, a hospital leases a cath lab facility, including the equipment and supporting employees, to a physician group (supplies are generally provided by the physicians and are not included in the lease arrangement due to variability in physician usage and product and vendor preferences). The physician group will pay a fair market value rental rate to the hospital for the use of the leased resources and then use the cath lab to perform its cardiac catheterization cases. The physician group will bill the appropriate payor for the professional fees related to the physician services rendered to the patient. The physician group will also bill for the “technical” fees related to the leased cath lab facility and other resources used to perform the cardiac catheterization procedure. These technical fees represent an additional revenue stream to the physicians that is typically billed by the hospital. To the extent that the technical revenue stream generated exceeds the rental payments made to the hospital, and any other operating expenses incurred by the physicians (such as medical supplies, billing and collection expenses, etc.), the physician group has created additional earnings. Example of a leasing arrangement. Hospital A is considering a way to increase the revenues of its under-utilized cath lab resources. ABC Physician Group (the Group) is a thriving cardiology practice that performs a variety of outpatient cardiac catheterization cases at a number of local hospitals. The Group is interested in an arrangement that can provide a fully equipped and dependable cath lab facility to use in treating its significant patient population while providing an additional source of revenues. Under a Lease Arrangement, Hospital A agrees to lease one of its fully equipped and staffed procedure rooms on a full-time basis to the Group for a fair market value rental rate. The Group schedules its outpatient cases to optimize these leased resources, with any overflow patient volume treated at the other local cath lab facilities that the Group also uses. The Group performs its own patient scheduling and billing/collection functions. Hospital A benefits by increasing the revenue of its cath lab resources and the Physician Group benefits through increased revenues and an additional cath lab to use in treating its patients. Purchased services agreement (PSA). Once a cath lab facility lease agreement is created between a hospital and a physician group, the parties should consider entering into a purchased services agreement (PSA). A PSA is an arrangement in which a hospital agrees to “purchase” certain services at fair market value prices from a physician group. The PSA can provide a contractual arrangement in which the hospital’s in-patients can receive immediate cardiac catheterization services during the time that the hospital’s cath lab is being leased to the physician group. In addition to providing inpatients with access to the leased cath lab, the PSA also provides a means of reimbursement to the physician group for the use of the leased cath lab resources. Since the hospital bills the appropriate payor for all technical fees related to the inpatient services provided, including cath lab services, the group cannot also bill payors for these technical services. Therefore, the PSA provides a mechanism for the physicians group to treat an inpatient. (Note: A PSA arrangement may also be considered in situations where the physician group already owns a cath lab facility and a contractual arrangement is needed to provide services to inpatients.) Example of a purchased services arrangement. After entering into a facility and services leasing arrangement, Hospital A and ABC Physician Group also decide to enter into a purchased services agreement (PSA). Under the PSA, the hospital’s in-patients will have access to the cath lab while it is being leased to the Group. The in-patients can be treated either by the Group’s physicians or by the in-patient’s physician of choice. The PSA includes a fee schedule, in which several inpatient procedures are listed along with the “technical reimbursement price” for each procedure. The technical reimbursement prices are based on fair market values. As in-patients are treated in the leased cath lab, the Group bills the Hospital according to the fee schedule in the PSA. If one of the Group’s physicians performs the cardiac catheterization procedure on the in-patient, then the Group will also bill the appropriate payor for the professional services rendered on the in-patient. What Legal/Financial Risks are Involved in These Arrangements? Legal considerations. Financial arrangements between hospitals and physicians must meet certain criteria to comply with federal government regulations, including applicable fraud and abuse statutes and self-referral statutes (commonly referred to as Stark II). Lease arrangements and purchased services contracts involving payments between a hospital and a physician group are considered financial arrangements. Therefore, parties that are interested in entering into these arrangements should hire qualified legal counsel that specialize in healthcare law and that are experienced in providing legal advice regarding transactions between hospitals and physicians. Valuation considerations. In addition to meeting certain legal criteria, any payments included in financial arrangements between hospitals and physicians must also satisfy various regulatory guidelines. These guidelines for payments require that the parties base the payment values on specific definitions for “fair market value” and “general market value” and that the arrangement is “commercially reasonable”. To satisfy these valuation criteria, the recently issued Stark II regulations encourage the use of an appraisal from a “qualified independent expert”.2 Therefore, hospitals and physicians contemplating leasing and/or purchased services arrangements should hire financial advisors that specialize in healthcare valuations and that have extensive experience in transactions between hospitals and physicians. Licensing considerations. Physician groups interested in leasing and operating a cath lab facility and billing payors for the technical services provided to patients will need to obtain all necessary licenses, permits, certifications, and approvals that may be required by the applicable city, state, and federal government agencies. This process can be fairly complicated and require a significant amount of time and effort. Qualified legal counsel should be hired to navigate through this complicated process. Business and financial risks. A cath lab lease, similar to other types of leases for equipment or office space, creates a financial commitment for the lessee. A physician group contemplating a cath lab lease arrangement needs to clearly understand its financial and business risks created by the lease agreement. The lease agreement should clearly define key operating issues, such as: • the facility space to be provided (procedure room(s), supply closets, etc.) and the hours of operation for the cath lab; • the equipment to be leased and who is responsible for the repair and maintenance and insurance related to the leased equipment; • the staff to be provided and what personnel costs will be passed along to the lessee; • and which party is responsible for providing the necessary medical supplies. The physician group should clearly understand the specific services that are included in the rental rate to be paid to the hospital and what additional products and services will be needed outside of the lease agreement (example: additional billing/collection personnel, licensing fees, legal/accounting fees, etc.). The physician group should also perform a feasibility study to determine if the forecasted net revenues related to the leasing arrangement justify the projected expenses. Likewise, the hospital lessor should also perform a similar feasibility study to determine if projected rental income to be paid by the physician group justifies the lost of the technical revenues that would have otherwise been retained by the hospital. Conclusion. If properly structured, leasing and purchased services arrangements involving cath lab facilities can provide financial rewards and relationship-strengthening opportunities between hospitals and physicians. Like most significant business ventures, while the process of negotiating and establishing cath lab leasing arrangements and purchased services agreements can be time consuming and require the use of specialized legal and financial advisors, the overall benefits to be gained may well justify the effort and expenses. Benefits to be gained from cath lab leasing arrangements and purchased services agreements. 1. Increased utilization of existing cath lab facility and staff; 2. More predictable rental revenue stream for the hospital; 3. Additional source of technical revenues for the physician group; 4. Additional cath lab facility and resources to treat a growing patient population; 5. Enhanced relationships between the hospital and physician group, resulting in fewer lost cases to competing facilities; 6. Ability to avoid costly and duplicate capital outlays in developing new cath lab facilities. Critical factors to be considered in cath lab leasing and PSA arrangements. 1. Hospital faced with an under-utilized cath lab facility and declining reimbursement rates; 2. Physician group in need of additional cath lab space and interest in developing an additional source of revenue; 3. Legal issues related to financial arrangements between hospitals and physicians; 4. Valuation issues related to lease rates and purchased services agreements; 5. Licensing requirements related to operating a cath lab facility; 6. Business and financial risks related to a leasing arrangement.
References
1. Cost Survey: 1997 Report Based on 1996 Data; and Cost Survey: 2001 Report based on 2000 Data, Medical Group Management Association. 2. 66 Federal Register, page 944, January 4, 2001