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New Stark Regulations Further Limit Physician-Hospital Relationships

August 19, 2008

On July 31, 2008, the 2009 final Hospital Inpatient Prospective Payment System (IPPS) rules were put on display at the Federal Register and on the Centers for Medicare and Medicaid Services (CMS) website, to be published in the Federal Register on August 19, 2008.

Included in the rules are certain amendments to the Stark Law regulations (the New Rules) that put in final form CMS conclusions concerning the application of the Stark Law to designated health services (DHS) provided “under arrangements” (i.e. by entities other than the entities that submit claims), and DHS provided using leased equipment or space paid for on a per click and percentage of fees basis. In addition, the New Rules refine the “stand in the shoes” provisions that apply to financial arrangements relying on the Stark regulations’ direct and indirect compensation exceptions. Taken together, these New Rules further limit physician arrangements with hospitals and other providers of DHS, and will require a revision or unwinding of a number of such arrangements.

1. DHS Provided “Under Arrangements.”

Before the New Rules, the Stark regulations defined “Entity” to be the entity to which CMS makes payment for DHS, directly or upon assignment. Under the New Rules, the definition of Entity is expanded to also include the person or entity that has performed services that are billed as DHS, whether or not it also is the entity that presents a claim to Medicare for the DHS.

Many hospitals outsource the provision of certain services they provide to their patients. The Medicare payment rules permit this outsourcing if the hospital maintains certain controls over the services provided by the outside supplier though its contractual relationship to the outside supplier. Medicare permits hospitals to bill for these services provided “under arrangements” as though they were performed by the hospital.

The outside supplier may be either wholly independent of the hospital and its medical staff, owned by the hospital with certain members of its medical staff as a joint venture, or wholly owned by certain members of its medical staff. Typically, the physicians who have an ownership interest in such an outside supplier are the same physicians who refer patients to the hospital for procedures to be performed by the outside supplier “under arrangement” with the hospital.

Before the New Rules, a physician could make referrals to the hospital for DHS that would be performed by an outside supplier under arrangements, even if the physician had an ownership interest in the outside supplier. This was because the rules barred referrals only to entities defined as the person or entity that bills Medicare for the DHS, not the person or entity that performs the DHS. CMS has for some time expressed concern that allowing these referrals risk over utilization.

Under the New Rules, physicians with an ownership interest in the outside supplier may not make referrals to the hospital for DHS if the DHS will be performed by the outside supplier. This is because, under the New Rules’ expanded definition of “entity,” making such referrals constitutes a referral to the outside supplier who performs the DHS as well as to the hospital. Such referrals can only be made if a Stark Law exception for an ownership interest in the outside supplier can be utilized, and such exceptions under Stark are not available in most circumstances.

Interestingly, the New Rules do not say what it means to “perform” DHS. In its comments, CMS states that the word “perform” should have its common meaning, and further says that, by way of example, physicians and other suppliers and providers generally know when they have performed a service and when they are entitled to bill for them. CMS goes on to say, however, that it does not consider an entity that leases or sells space or equipment used for the performance of the service, or that furnishes supplies that are not separately billable but used in the performance of the medical services, or that provides management, billing services, or personnel to the entity performing the service, as the entity that “performs” the DHS.

Those hospitals that have “under arrangements” contracts with outside suppliers that are at least in part owned by physicians who refer patients for DHS performed by the outside supplier will need to restructure or unwind the relationship. The effective date of this New Rule is delayed until October 1, 2009, to give parties time to restructure or unwind arrangements that do not comply with the New Rule.

2. Per Click and Percentage Based Space and Equipment Leases.

Under the Stark regulations, compensation must be set in advance. The regulations regard as set in advance compensation arrangements that are time-based or per-unit amounts, or a specific formula for calculating the compensation, provided the arrangement or formula is set forth in an agreement between the parties before the furnishing of the items or services for which the compensation is to be paid.

CMS has expressed concern about those percentage based compensation arrangements in which the compensation is based on fluctuating or indeterminate measures or in which the arrangement results in the seller receiving different payment amounts for the same service from the same purchaser. However, CMS held back from enacting any rule related to such percentage based compensation formulas because it was aware of physician compensation arrangements based on such formulas that it felt were not abusive.

Then CMS learned that certain leases for equipment and space contained lease payment formulas that calculate the amount due based upon the revenue generated by use of the leased equipment and space, or based upon the use of the equipment or space using a so called per click formula. This raised its level of concern.

In response, CMS has now adopted a final rule targeted to leased equipment and leased office space where the lease payments are determined as a percentage of revenue earned by the lessee when using the leased equipment and/or leased office space, or where the lease payments are determined on a per use basis when using the leased equipment and/or leased office space.

The New Rules include language in the Stark exceptions for each of rental of office space, rental of equipment, fair market value compensation in connection with the rental of equipment, and indirect compensation arrangements in connection with the rental of office space and/or equipment that bar compensation determined using a formula based on:

         (i) a percentage of the revenue raised, earned, billed, collected, or otherwise attributable to the services performed or business generated in the office space or to the services performed or business generated through the use of the equipment; or

         (ii) per-unit of service rental charges, to the extent that such charges reflect services provided to patients referred between the parties.

CMS has not extended the rule barring the use of percentage-based compensation to arrangements for any non-professional services, such as management or billing services, but indicates in its comments that it intends to continue to monitor such arrangements.

CMS received comments from a number of commentators urging it to allow percentage based compensation arrangements as a mechanism to encourage physician behaviors that achieve better quality, patient satisfaction or efficiencies, and in support of clinical integration and coordination. The commentators asked CMS to permit such compensation mechanisms so that physicians can receive a share the cost savings achieved by their efforts.

CMS responded in its commentary to the New Rules that a number of these concerns were addressed by its narrow targeting of limitations on such compensation arrangements to equipment and office space leases. This keeps the door open for management agreements, and for properly structured, non-abusive incentive payment and shared savings programs. However, CMS referred readers to its proposed rule for gain sharing arrangements, and cautioned against the possibility of compensation that may exceed fair market value using a percentage based compensation formula in shared savings programs. Parties are free to structure arrangements using other permissible compensation methodologies, including flat-fee payments set at fair market value, and unless otherwise prohibited as discussed below, per-procedure compensation. CMS adds that block time leasing or similar forms of rental payment formula may be used, provided the block of time leased is not too small, such as a four hour block once a week.

With respect to the per click rental charge prohibition, CMS notes that only the rental charges that reflect services provided to patients referred between the parties is subject to the prohibition. Thus, rental fees per click may be paid for services provided to patients who are not referred by one party to the arrangement.

The prohibition on per click rental fees applies regardless of whether the referring physician is the lessor or whether the lessor is an entity in which the referring physician has an ownership or investment interest. It also applies where the lessor is a DHS entity that refers patients to a physician lessee or a physician organization lessee.

Those leasing arrangements using a percentage-based rental fee or a per click rental fee for equipment and/or office space will need to be restructured, or unwound. The effective date of this New Rule is delayed until October 1, 2009, to give parties time to restructure these arrangements.

3. “Stand in the Shoes” Rules for Direct and Indirect Compensation Arrangements.

The Stark regulations prohibit physicians who have a direct or indirect financial relationship with an entity from making a referral to that entity for the furnishing of DHS for which payment may be made under Medicare, unless an exception to this prohibition exists in the regulations. Financial relationships include ownership and investment interests, and those involving compensation.

The exceptions commonly relied upon to permit such referrals include those for in-office ancillary services, services provided by an academic medical center, and those for office leases, equipment leases, employment relationships, personal service arrangements, physician recruitment, isolated transactions, fair market value, indirect compensation arrangements, and provision of electronic health records technology, among others.

The threshold question with respect to compensation is whether the referring physician has a direct or indirect compensation arrangement with the DHS Entity (as now defined to include not only the entity that bills for the DHS, but also the entity that performs the DHS, as discussed above).

A direct compensation arrangement is one in which the remuneration passes between the DHS entity and a referring physician without intervening persons or entities. Examples include the relationship between an employed referring physician and that physician’s employer, or the relationship between a hospital and a referring physician who serves as a medical director for the hospital.

Under current Stark regulations, a physician is also deemed to have a direct compensation arrangement where the only intervening entity between the physician and the entity furnishing DHS is his or her physician organization, i.e. the physician is deemed to “stand in the shoes” of his or her physician organization. A physician organization includes the physician’s professional corporation, physician practice (i.e. one that employs or contracts with the referring physician or in which the referring physician has an ownership interest), or a group practice as defined in the Stark regulations.

An indirect compensation arrangement prior to the New Rules is one that:

  • connects a referring physician and an entity that provides DHS with an unbroken chain of any number of persons or entities that have financial relationships between them, including either ownership or investment interests or a compensation arrangement with the preceding link, and in which the referring physician receives compensation from the person or entity in the chain with which the physician has a direct financial relationship that varies with or takes into account the volume or value of referrals or other business generated by the referring physician for the entity furnishing the DHS; and
  • if the financial relationship that the referring physician has with the entity closest to him or her is an ownership or investment interest, then the determination of whether the compensation varies with or takes into account the volume or value of referrals or other business generated by the referring physician for the DHS entity will be measured by the non-ownership or non-investment interest closest to the referring physician; and
  • a referring physician is deemed to “stand in the shoes” of his or her physician organization, and is thus deemed to have the same compensation arrangements with the DHS entity that his or her physician organization has with DHS entity.

However, the effective date of the above stand in the shoes rules for both direct and indirect compensation arrangements was delayed for academic medical centers and tax exempt integrated health care systems to permit CMS to consider the concerns expressed by these organizations after the rule was issued. The delay resulted from concerns expressed by academic medical centers and tax exempt integrated health systems, both of which rely on “mission support payments” that move between entities within the centers and systems.

Mission support payments typically move from the hospitals within the centers/systems to the physician organizations within the centers/systems to help support the missions of the centers/systems, but which are typically not tied to specific items or services, and thus could not meet the Stark exceptions for compensation arrangements or similar exceptions. In the past, these centers/systems relied on their employment agreements between their physicians and their physician organizations within their centers/systems that do meet the employment exception to in turn meet the indirect compensation exception, or in the alternative, they took the position that such payments don’t vary with the volume or value of referrals or other business generated within their centers/systems and thus are outside the definition of indirect compensation and the Stark Law altogether. While the academic medical center exception could be relied upon by academic medical centers, many centers chose not to rely on that exception because of its complexities and uncertainties.

The stand in the shoes rules as described above would require employed physicians within such centers/systems to stand in the shoes of their physician organizations, and thus such physicians would be deemed to have the same contractual relationship with the DHS entities within their centers/systems as their physician organizations have with the system DHS entities making the payments. As a result, mission support payments from center/system DHS entities would violate the Stark prohibition on physician referrals to the DHS entities within their centers/systems.

CMS has now settled on what it calls a more refined approach to the stand in the shoes provisions. It has dropped altogether an earlier proposal requiring the DHS entities themselves to stand in the shoes of entities that they own. It has narrowed the application of the stand in the shoes rules to physicians only, and then generally only to physicians with an ownership or investment interest in their physician organizations.

Under the New Rules, a referring physician is deemed to stand in the shoes of his or her physician organization and have a direct compensation arrangement with an entity furnishing DHS if the only intervening entity between the physician and the DHS entity is his or her physician organization, and the physician has an ownership or investment interest in the physician organization (unless such ownership or investment interest is merely titular, meaning the physician has no right to receive profits, proceeds of sale, or similar returns on investment).

The New Rules also provide that referring physicians who are neither owners nor investors are permitted, but not required, to stand in the shoes of their physician organizations, and have the same compensation relationship to the DHS entities as exist between their physician organizations and the DHS entities.

The same change was made under the New Rules to determine the existence of an indirect compensation relationship, i.e. a referring physician stands in the shoes of his or her physician organization, but only if the physician has an ownership or investment interest in the physician organization, unless such interest is merely titular, and other referring physicians are permitted, but not required, to stand in the shoes of their physician organizations.

Why would non-owner physicians wish to stand in the shoes of their physician organizations? If the compensation arrangement between a referring physician who is an employee or an independent contractor of the physician organization cannot meet the Stark exception for employment agreements or for compensation arrangements for any reason, but the physician organization’s agreement with a DHS entity does meet an exception, the physician is permitted to take advantage of his or her physician organization’s compliance with the exception.

CMS did not include in the New Rules an exception for “mission support payments” as desired by some commentators. However, the New Rules exclude application of the stand in the shoes provisions to arrangements that satisfy the requirements of the academic medical center exception under the Stark regulations. Also, if referring physicians who are employed by physician organizations that are within an academic medical center or an integrated health care system who also do not have the attributes of an ownership or investment interest in their physician organization, then they are not required to stand in the shoes of their physician organization for purposes of the direct and indirect compensation provisions of the Stark regulations.

The stand in the shoes provisions of the New Rules are effective on October 1, 2008, but will not apply during the original term or current renewal term of an arrangement that satisfied the requirements of the indirect compensation exception on September 5, 2007.

4. Other Provisions

The New Rules expand the Stark exception for obstetrical malpractice insurance subsidies provided to physicians for practices located in a primary care HPSA, rural area, or area with a demonstrated need as determined by the Secretary of the Department of Health and Human Services, or is comprised of patients at least 75 percent of whom reside in a medically underserved area or are part of a medically underserved population.

The New Rules also make clear that a physician is not deemed to have an ownership or investment interest in an entity arising from a retirement plan offered by that entity to the physician through the physician’s employment with that entity. Other retirement plans could be the basis for an ownership or investment interest under the Stark regulations.

5.  Summary

The New Rules require a review and restructuring or unwinding of hospital under arrangements contracts with entities that are at least party owned by physicians who refer patients to the hospital for services that are performed by such entities.

The New Rules also require the unwinding or restructuring of office leases and equipment leases that provide for the payment of rent calculated as a percentage of revenue generated by use of such offices or equipment arising from patients referred to one of the lease parties, or rent calculated on per click basis again arising from patients referred to one of the lease parties.

Finally, the New Rules will require a potential restructuring or unwinding of direct and indirect compensation arrangements where referring physicians have an ownership interest in or investment interest in their physician organizations, and their physician organizations have a direct or indirect compensation arrangement with DHS entities.

Hospitals and physician organizations having any of the arrangements described above should review their agreements promptly. They have until October 1, 2009, to make necessary changes to their under arrangements contracts and leases, but only have until October 1, 2008, to make any necessary changes to their direct or indirect compensation arrangements.

For more information regarding new regulations or other healthcare issues, contact Michael Skindrud, team leader of Godfrey & Kahn's Heathcare Practice Group, at mskindrud@gklaw.com or by telephone at (608) 284-2619.

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