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The Future of Physician-Owned Hospitals, Contributed by Victor L. Moldovan, McGuireWoods, LLP

Monday, August 8, 2011

By Victor L. Moldovan, McGuireWoods, LLP


In many communities in the United States, physicians were responsible for the development and ownership of hospitals. During the Stark law era, the relationship between physicians and hospitals has come under stricter scrutiny. The Stark law is premised on the concept that a physician should not be permitted to refer patients to facilities in which the physician has an ownership interest or other financial relationship. The purpose of the law is to reduce financial incentives paid for by Medicare, Medicaid, and other federal programs for physicians to overutilize health care services. Significantly, until the adoption of the Affordable Care Act (ACA), the Stark law had an exception, commonly referred to as the “Whole Hospital Exception,” from the prohibition on referrals by physicians to hospitals in which the physicians had an investment interest. As a result of the exception, physicians were free to own hospitals as long as the ownership interest was in the whole hospital and not just a department, such as surgery or radiology. However, ACA abolished the whole hospital exception for new hospitals and significantly limited the expansion of existing hospitals.

Stark Law

The Stark law essentially prohibits a physician from referring Medicare, Medicaid, and other federally covered patients to a provider that provides designated health services (DHS).1 The first DHS was clinical laboratories owned by physicians. The federal government determined that physicians may be over utilizing lab services and billing for those services where the physician owns the lab. Later, the government expanded DHS to include inpatient and outpatient hospital services.2 Again, the concept underlying the prohibition was that if physicians had any financial relationship with entities providing DHS, the physicians would overutilize those services because they would be financially compensated. The validity of that assumption has been the subject of much debate and challenge by the physician community, but the fact is that the federal government believes that the assumption is true and has adopted the Stark law to limit the incentives for such over utilization in Medicare, Medicaid, Champus, and other programs funded by the federal government. The result is that a physician may not refer a patient for DHS if the physician has any financial relationship with the entity that provides the DHS unless there is an exception.

Whole Hospital Exception

The Stark law’s scope includes every type of relationship between a physician and any entity that provides DHS. The Stark law effectively made those relationships problematic, subjecting the physicians and the DHS providers to recoupment actions, civil penalties and possible exclusion from Medicare, Medicaid, and other federally funded programs. It also increased dramatically the possibility of false claims actions brought by individuals against the physicians and DHS providers. The federal government recognized the ramifications of the Stark law and adopted a number of different exceptions to it, including the Whole Hospital Exception, which allowed physicians to own a hospital or part of a hospital as long as the investment interest is in the entire hospital.3 The exception included hospitals in existence at the time the law was adopted and those that were developed after the law was adopted.

In order to qualify for the whole hospital exception, a physician hospital relationship must meet several requirements The physician must only receive financial benefits from his or her ownership based on his or her pro rata interest in the hospital. For example, if the physician owns 10 percent of the hospital’s stock the physician is authorized to receive only 10 percent of the profits. The physician cannot receive remuneration based on the volume or value of his or her referrals to the hospital. In other words, the physician cannot be paid an amount based on the number of patients he refers to the hospital for inpatient and outpatient services. Even if the physician is responsible for 50 percent of the patients seen by the hospital the physician is only authorized to receive his or her pro rata share of the profits. Again, if the physician owns 10 percent of the hospital’s stock then he or she may only receive 10 percent of the profits even if he or she is responsible for 50 percent of the patients treated at the hospital.

By allowing a physician to receive only a pro rata share of a hospital’s profits based on his or her respective ownership interest in the hospital, rather than on the volume of referrals to the hospital, the incentive for the physician to overutilize the hospital (and drive up the cost to Medicare) was reduced. As a practical matter, most physicians own only a very small percentage of a hospital. At the time the Whole Hospital Exception was adopted, the thinking of the federal government was that ownership by itself was not a significant incentive to refer patients to the hospital.4 In fact, payment by Medicare, Medicaid and other federal government programs is contingent on the services being medically necessary; those programs do not pay for services that are not medically necessary regardless of where they are provided. As a result, before the adoption of the ACA, the federal government apparently believed that the restrictions on ownership by a physician in a hospital did not cause over utilization of services or increase the risk of the unnecessary expenditure of funds by Medicare, Medicaid and other federally funded programs.

ACA

The ACA abolished the whole hospital exception for new hospitals and significantly limited the expansion of existing hospitals.5 Those hospitals with physician ownership as of March 23, 2010, are grandfathered for the same percentage of physician ownership they had on that day. For example, if a hospital had 20 percent physician ownership on March 23, 2010, is the ACA allows it to keep 20 percent physician ownership without violating the law, but the percentage physician ownership cannot increase beyond 20 percent. If the hospital was not yet enrolled in Medicare as of March 23, 2010, it had until December 31, 2010, to enroll and whatever percentage of physician ownership it had at that time was the maximum amount it could have in the future. The ACA bars any new ownership in hospitals after December 31, 2010.

The restrictions on expansion also include limits on the number operating rooms, inpatient beds and procedure rooms at physician owned hospitals. The ACA capped these rooms and beds at their March 23, 2010 amount, or their December 31, 2010 amount, if the hospital was not yet enrolled in Medicare as of March 23, 2010. The result is that there will be no new Medicare enrolled physician owned hospitals in the United States and those that exist have restrictions on expansion.

Litigation

The restrictions on physician ownership of hospitals were addressed specifically in the case filed by Physician Hospitals of America (PHA) and Texas Spine and Joint Hospital (TSJH) (collectively, the Plaintiffs) in the U.S. District Court for the Eastern District of Texas.6 Unlike the cases filed in other federal courts challenging the mandatory insurance provision, the Texas case focused solely on the Whole Hospital Exception. The Plaintiffs argued that the Whole Hospital Exception repeal by ACA violated the hospitals’ due process and equal protection rights under the Fifth Amendment to the U.S. Constitution, resulted in a taking by the federal government of property without due compensation, and was vague regarding the Whole Hospital Exception. Moreover, they argue that the ACA singled out physician owned hospitals for unreasonable treatment as compared to other types of hospitals.

On March 31, 2011, the court held that the Plaintiffs had a valid claim that was ripe for adjudication and they were not required to wait until they were cited by the federal government for non-compliance or for an application for enrollment for a new hospital to be denied before challenging the law. The Court granted, however, the Secretary’s motion for summary judgment on the merits of the case.7 The court basically held that Congress did not act unreasonably by repealing the Whole Hospital Exception for new hospitals, that there was not a taking of property, and that the law was not unconstitutionally vague.

On Friday, May 27, 2011, the Plaintiffs appealed to the Fifth Circuit Court of Appeals.

What Happens Next

The repeal of the Whole Hospital Exception on physician ownership of hospitals clearly had a chilling effect on new Medicare enrolled hospitals and the expansion of existing hospitals. But, that is not the end of the story.

Until the Fifth Circuit rules on the Plaintiffs’ appeal, it is too early to say exactly what will happen because the court’s decision could be reversed or modified in a myriad of ways. If the court’s decision is reversed, the repeal of the Whole Hospital Exception will be invalid.

Further, the case brought by the State of Florida and other states challenging the ACA cannot be overlooked.8 In that case, the Northern District of Florida struck down the entire ACA.9 The court wrote:

In the final analysis, this Act has been analogized to a finely crafted watch, and that seems to fit. It has approximately 450 separate pieces, but one essential piece (the individual mandate) is defective and must be removed. It cannot function as originally designed. There are simply too many moving parts in the Act and too many provisions dependent (directly and indirectly) on the individual mandate and other health insurance provisions — which, as noted, were the chief engines that drove the entire legislative effort — for me to try and dissect out the proper from the improper, and the able-to-stand alone from the unable- to-stand alone. . . . The Act, like a defectively designed watch, needs to be redesigned and reconstructed by the watchmaker. . . .


Because the individual mandate is unconstitutional and not severable, the entire Act must be declared void.10

The U.S. Government appealed the Florida decision to the 11th Circuit Court of Appeals. If the Eleventh Circuit does not reverse or modify the decision, all provisions of the ACA will be invalid, including the repeal of the Whole Hospital Exception. The result will be that the Whole Hospital Exception as it existed prior to the adoption of the ACA will continue in force and new physician owned hospitals will be allowed to enroll in Medicare.

It should be noted that new bills have been introduced in Congress to address the Whole Hospital Exception.11 Thus, it is possible that regardless of what happens in the courts, the law will be changed by Congress.

Finally, even if Section 6001 is upheld and not repealed legislatively, the existing physician owned hospitals may still undertake a wide variety of business development activities. They can add new services, joint venture for non-hospital based services such as outpatient imaging, radiation therapy, chemotherapy, and dialysis. They can also use their existing physical structures to meet new business opportunities as long as they don’t increase the aggregate number of beds, operating rooms or procedure rooms. For example, they are free to convert in-patient beds to operating rooms or procedure rooms to meet patient demand, as long as the total number of beds, operating rooms, and beds does not increase.

The ultimate impact of Section 6001 remains to be seen. The resolution of pending litigation and the legislative efforts may dramatically change the law. Even if the law is not changed, physician owned hospitals can continue to operate and manage their business within the confines of the law.

Victor Moldovan is a Partner in the Heath Care Section of McGuireWoods LLP in Atlanta, Georgia. He represents healthcare providers in state and federal regulatory matters, litigation and transactions. His clients include hospitals, ambulatory surgery centers, home health companies, hospice, medical practices and ancillary services. He advises on Medicare, Medicaid and FDA compliance matters, federal and state conditions of participation, licensure, operational issues, quality issues and structures for mergers and acquisitions. He can be reached at vmoldovan@mcguirewoods.com or 404-443-5708.

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