• Jason Ruchaber, CFA, ASA

Value Based Medicine and Business Valuation



The Affordable Care Act set in motion a myriad of changes to the healthcare industry, including a fundamental shift in the perception of “healthcare”. Our current system is designed to provide what some have appropriately referred to as “sick-care”, with insurance policies, patient behaviors, treatment protocols, and reimbursement all designed to coincide with the onset and subsequent treatment of illness or disease. The concept of “healthcare” is now being redefined to focus on the overall health of populations while improving the patient experience and reducing the per capita cost of care – the triple aim. Though there is significant disagreement and uncertainty as to how these objectives might be accomplished, the most likely path will be some variant of value-based medicine.

According to the Center for Value-Based Medicine, value-based medicine is “the practice of medicine based upon the objective value (improvement in length-of-life and/or quality-of-life) conferred by healthcare interventions as determined by utilizing a set of standardized parameters commonly used to evaluate value and cost-effectiveness.” Practically speaking, value-based medicine requires a retooling that aligns the payment mechanism to incentivize prevention, quality patient care, and treatment protocols with the best outcomes relative to their cost. This also entails a migration from our current fee-for-service model into one or more value-based models such as shared savings, pay-for-outcomes, pay-for-quality, etc.

The shift away from fee-for-service is a monumental task that will likely take many years to accomplish and will be met with fierce opposition from those who benefit under the current model. But even now, while the path is yet to be defined, the industry is mobilizing resources and investing massive amounts of capital to prepare for the new future of healthcare. As a business appraiser this can be readily seen in the massive consolidation going on in the industry, which has evolved from the acquisition of physician practices, to the purchase of ambulatory services, hospital acquisitions, and now mega-system mergers such as Tenet/Vanguard and CHS/HMA. I have been directly involved in many of these deals, but as the industry continues to evolve I can’t help but wonder if we are adequately accounting for these changes in our valuation models.

In the healthcare industry, deals must generally be priced at fair market value (“FMV”) as defined in the Stark Law. There are numerous resources that discuss the nuances of complying with this definition of FMV, and I will not recount them here. It is important to note, however, that FMV precludes consideration of any buyer-specific synergies, and appraisers generally avoid making significant alterations to the existing revenue and cost structure of the business when building their forecasts and valuation models. Moreover, appraisers generally use historical performance as a basis for these models, extrapolating the past as a means to project the future. In our fee-for-service world, this entails modeling some volume metrics such as work RVUs, procedures, scans, etc., applying reimbursement rates based on existing levels plus inflation and/or MedPac guidance, and modeling variable costs in a similar fashion. But how can this result in the fair market value of a business when the future likely looks nothing like the past? More importantly, how does valuing a healthcare business in this fashion adequately differentiate values for high quality vs. lower quality practices?

These are not easy questions, and finding the answers is made more difficult by constant legislative posturing, undefined quality metrics, and uncertain future payment mechanisms, etc. Despite these challenges, it is my belief is that like other industry participants, business appraisers must rethink many of the quantitative and qualitative elements of the appraisal process to comport with the realities of the industry. Of course finding consensus on anything in the healthcare industry is difficult, but we need to have constructive dialogue to evolve our processes to stay relevant in this rapidly changing industry.

Here is my list of the five things to consider for healthcare valuation engagements:

  1. The past is not indicative of the future

The use of a discounted cash flow model that extrapolates the past may not result in an accurate valuation.Projected financials developed under a premise of fee-for-service do not likely reflect the current economic realities of the healthcare industry. Valuation models should consider the various forms future reimbursement models may traverse, and consider whether these models will result in a net positive or deterioration of the revenue and profits of the business.

  1. Higher quality should equal higher value

Anyone who has spent any time in healthcare understands that the rules of statistics don’t apply.Has anyone ever heard of a physician performing below the 75th percentile?Joking aside, poorly performing physicians and low quality healthcare businesses do exist.Unfortunately, under fee-for-service high quality does not always translate into high profit or high value (or vice versa).Taking more time with your patient, taking action to subsequent visits or additional tests, avoiding surgical intervention when non-surgical treatment is available - these behaviors all result in lower revenue and lower profits in our current environment.From a purely financial viewpoint, this may also result in the highest quality practices receiving the lowest valuations.Not only is this counterintuitive, but it is likely wrong.Higher quality should result in higher value, particularly in a world moving to value-based medicine.But how do we measure quality?Unfortunately, the metrics are not yet defined, and comparative data is limited.But this is changing (see item # 3 below) and appraisers should seek to assimilate new data into their valuation process as it becomes available.In the meantime, appraisers should work with administrators and medical directors to understand the various quality initiatives currently in place, and develop risk scoring algorithms to adjust valuation discount rates to reflect elements of quality.Cash flow forecasts should also reflect incentive payments and cost savings initiatives with probability adjustments for the likelihood of realization.

  1. Information Technology Matters

Information technology and the use of big data has finally made its way to the healthcare industry.The HITECH Act, passed in 2009, helped facilitate the start of this transition, and I expect significant advances in clinical care and population health will result.Those healthcare businesses that have already started to incorporate information technology into their practices are much better positioned to succeed in this new era of healthcare.Like high quality clinical practices, however, the investment and initial inefficiency caused by technology implementation may lead to the incorrect conclusion that the business is worth less.Implementing IT infrastructure and processes is expensive, and may lead to lengthy periods of suppressed cash flow.However, appraisers need to recognize and incorporate adjustments to reflect future returns on this investment, and conversely, recognize that those practices who have not already started the process face significant capital investment and competitive disadvantage relative to those who have.This brings me to my next point. . .

  1. Capital Expenditures

High quality care, better outcomes, and an improved patient experience cannot happen with antiquated equipment and facilities.The uncertainty and declining reimbursement faced by industry participants has led many businesses to delay or avoid necessary capital expenditures.This reinforces the need to conduct onsite inspections with business appraisals, and further highlights the role quality should play in the valuation process.Valuations of businesses that have not invested adequately in capital equipment should be penalized with cash flow reductions and an increase in the discount rate.

  1. Pricing transparency

Recently CMS released data for the 100 most common inpatient services, 30 common outpatient services, and all physician and other supplier procedures and services performed on 11 or more Medicare beneficiaries. Many hospitals and health systems are voluntarily releasing similar pricing data or making efforts to do so.As patients become more financially responsible for the cost of their care, and as providers release data regarding the prices of their services, we may see the advent of consumerism in healthcare.This stands to fundamentally change patient behaviors and preferences, and solidifies the importance of quality in healthcare.Businesses that have historically enjoyed higher prices and/or more favorable payor contracts may find that patients no longer see the value associated with their facility.Conversely, those with the highest quality outcomes and highest patient preference may see demand, and prices, start to go up as a result.For appraisers, this argues for more comprehensive benchmarking of both prices and outcomes and a recognition that historical payor leverage may fade as the consumer becomes more informed and empowered.

Though the term “value” means different things to different people, we should be actively seeking to find ways to identify, measure and attribute financial value to the businesses and behaviors most likely to bring positive and lasting change to our industry.

#fairmarketvalue #businessvaluation #Healthcare

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