Understanding Mergers and Acquisition in the Healthcare Marketplace

1. Understanding Mergers and Acquisition in the Healthcare Marketplace May 2011

2. Understanding the Healthcare M&A Marketplace • Overview of Business Activity • The healthcare market is consolidating • We will focus on the northeast market – NJ/NY/PA • Consolidation is mostly in the following sectors: • Hospitals • Surgery Centers • Physician Practices • Few negotiations have been finalized to-date • The average time estimate for the negotiation process is 15 to 18 months – Some in excess of 3 years • Friendly PC, Leased Provider, Employee or Hybrid entity choices in these deals 2

3. Understanding the Healthcare M&A Marketplace • Case Study #1 • Situation • Practice experiences an initial decline in cash flow • Practice has started to see more overpayment audits • Practice has a sound business model • Practice has an effective management team • Local health system announces a business strategy to merge with physician practices • Practice requests to be considered for merger • Negotiations start with both parties 3

4. Understanding the Healthcare M&A Marketplace • Case Study #1 • Result of practice assessment • Net collection opportunity to increase cash flow annually • Significant overcoding in practice • Numerous business process recommendations • Health system reimbursement higher than practice • Staffing levels in line with surveys • Overhead percentage slightly higher than surveys • Good payer mix • Respected brand name in the community 4

5. Understanding the Healthcare M&A Marketplace • Case Study #1 • Outcome of Negotiations to-date • Negotiations are still active – 12 months to-date • Talks progressed from merger to acquisition • Effort to increase physician compensation - wRVU • Entity discussion towards a friendly PC model • Billing under the tax ID of the health system • Strategic fit for health system/practice • Cultural fit for health system/practice • Value to business model • Value to branding 5

6. Legal Issues Brief Background of Important Laws • Stark and Anti-Kickback laws prohibit payments in exchange for referrals of services paid for by Medicare/Medicaid • Anti-Kickback Statute (AKS): • Intent-based statute • Bona-fide reasons for transaction (e.g., integration) • Criminal and civil penalties

7. Legal Issues cont’d • Stark law • Strict liability • Civil penalties • Compensation cannot be based on “volume/value of referrals” of designated health services • Exception: personally performed services (e.g., wRVU) • How to structure compensation? • “Eat what you kill” • Compensation pools

8. Legal Issues cont’d • FMV/commercially reasonable payments • Important: independent valuation report from reputable source • Recent case law (whistleblower actions): • U.S. ex. rel. Singh v. Bradford Regional Medical Center • Hospital paid group fixed fee for equipment sublease and non-compete • FMV fee should not take into account anticipated referrals in certain cases. • Court found fixed fee took into account future referrals

9. Legal Issues cont’d • U.S. ex. rel. Drakeford v. Tuomey • Hospital employed physicians part-time for its outpatient surgery center • Physicians paid 131% of their collections (national data cites 49%-63%) • Physicians exclusive to Tuomey • Court found physicians’ compensation inflated to take into account their referrals because each surgery generated a PC and a TC.

10. Legal Issues cont’d • Case Study #1: • Potentially large upfront payment to physicians • Loss of control/decision-making • Broad non-competes • Harder to unwind • Public disclosure of information if tax-exempt Captive PC

11. Understanding the Healthcare M&A Marketplace • Case Study #1 • Insurance Summary • Property- Insurable interest and contract covenants • Stark-Fines, Penalties, Defense • Billing and Coding-Fines and penalties for overcoding • General Liability will not cover dishonest acts. Innocent parties may be covered in the D&O policy • Medical Malpractice-Form of risk transfer and legacy issues • Management Protection Coverage • Who owns the policies? 11

12. Understanding the Healthcare M&A Marketplace • Case Study #1 • Insurance Summary • Employment Practices-Declining cash flow • Workers Compensation-Combinable entities • Directors and Officers-Run Off Coverage • Fiduciary Liability-Separate entity for employees 12

13. Understanding the Healthcare M&A Marketplace • Case Study #1 • Insurance Summary • Directors and Officers-Unsound business model • Workers Compensation-Leasing situation • Crime Insurance-Adequate staffing vs. low productivity 13

14. Understanding the Healthcare M&A Marketplace • Case Study #2 • Situation • Practice experiences a consistent decline in cash flow • Practice has started to experience overpayment audits • Practice has a sound business model • Practice has a respected brand name • Practice does not have an effective management team • Founding partner is nearing retirement • Local health system has been talking to the practice • Practice requests to be considered for merger • Negotiations start with both parties 14

15. Understanding the Healthcare M&A Marketplace • Case Study #2 • Result of practice assessment • Practice productivity lower than survey median • Collections per physician are at the survey median • Health system reimbursement higher than practice • Numerous business process recommendations • Staffing levels in line with surveys • Overhead percentage in line with surveys • Good payer mix • Respected brand name in the community 15

16. Understanding the Healthcare M&A Marketplace • Case Study #2 • Outcome of Negotiations to-date • Negotiations are on hold • Talks progressed from merger to acquisition • Problem with valuation of practice • Effort to increase physician compensation - wRVU • Entity discussion towards a hybrid model • Friendly PC model for physicians • Separate entity for employees • Billing under the tax ID of the health system • Strategic fit for health system/practice • Cultural fit for health system/practice • Value to business model • Value to branding 16

17. Legal issues • Case Study #2: • AKS • Bona fide reasons for transaction • Potential areas of concern: • Deferred compensation • Retained liabilities • Preserving group unity (e.g., effect of termination of one or more physicians)

18. Understanding the Healthcare M&A Marketplace • Case Study #2 • Insurance Summary • Property- Insurable interest and contract covenants • Billing and Coding-Fines and penalties for overcoding • Medical Malpractice-Form of risk transfer and legacy issues • Management Protection Coverage • Who owns the policies? 18

19. Understanding the Healthcare M&A Marketplace • Case Study #2 • Insurance Summary • Employment Practices-Declining cash flow, may have to reorganize • Workers Compensation-Combinable entities, effect on reporting of payouts • Directors and Officers-Run Off Coverage • Fiduciary Liability-Separate entity for employees 19

20. Understanding the Healthcare M&A Marketplace • Case Study #2 • Insurance Summary • Directors and Officers-Unsound business model • Workers Compensation-Leasing situation • Crime Insurance-Adequate staffing vs. low productivity 20

21. Understanding the Healthcare M&A Marketplace • Case Study #3 • Situation • Practice experiences a significant decline in cash flow in the last 12 to 15 months • Practice has started to experience overpayment audits • Practice does not have a sound business model • Practice has a respected brand name • Practice does not have an effective management team • Local health system has been talking to the practice for an extended period of time • Practice requests to be considered for merger • Negotiations start with both parties 21

22. Understanding the Healthcare M&A Marketplace • Case Study #3 • Result of practice assessment • Practice productivity lower than survey median • Collections per physician are at the survey median • Numerous business process recommendations • Health system reimbursement higher than practice • Staffing levels in line with surveys • Overhead percentage in line with surveys • Good payer mix • Respected brand name in the community 22

23. Understanding the Healthcare M&A Marketplace • Case Study #3 • Outcome of Negotiations to-date • Negotiations are continuing to-date • Talks progressed to a leased provider arrangement • Health system is leasing providers • No acquisition of practice by the health system • Effort to increase physician compensation - wRVU • Billing under the tax ID of the health system • Strategic fit for health system/practice • Cultural fit for health system/practice • Value to business model • Value to branding 23

24. Legal Issues • Case Study #3: • AKS and Stark: • Bona fide reasons: is there real integration? • Potentially, fewer issues under Stark • If non-compete included, Bradford suggests: • Non-competes in leases may be more problematic • Non-competes may be viewed as a requirement to refer • Easy to unwind

25. Understanding the Healthcare M&A Marketplace • Case Study #3 • Insurance Summary • Property- Insurable interest and contract covenants • Billing and Coding-Fines and penalties for overcoding • Medical Malpractice-Form of risk transfer and legacy issues • Management Protection Coverage • Who owns the policies? 25

26. Understanding the Healthcare M&A Marketplace • Case Study #3 • Insurance Summary • Employment Practices-Declining cash flow • Workers Compensation-Combinable entities • Directors and Officers-Run Off Coverage • Fiduciary Liability-Separate entity for employees 26

27. Understanding the Healthcare M&A Marketplace • Case Study #3 • Insurance Summary • Directors and Officers-Unsound business model • Workers Compensation-Leasing situation • Crime Insurance-Adequate staffing vs. low productivity • EPLI – Non-competes • D&O – “Insured vs. Insured” 27

28. Legal Issues • Impact of Health Reform on M&A deals: • Patient Protection & Affordable Care Act of 2010 (“PPACA”) • Value-based purchasing: • Transforms Medicare from “passive” purchaser to “active” purchaser • How? • Modifies Part A and Part B payments for achieving/reporting quality standards

29. Legal Issues • Accountable Care Organizations (“ACOs”) • Definition: Group of providers with joint responsibility for quality and cost of care provided to assigned Medicare beneficiaries • Proposed Regulations Issued March 31, 2011 by CMS, as well as regulatory guidance from OIG, CMS, FTS, DOJ and IRS.

30. Legal Issues cont’d • Significant Details Include: • ACO must be a legal entity under State law (e.g., corporation, LLC) • ACO must have TIN but need not be enrolled in Medicare • ACO participants: physicians, physician practices, networks of physician practices, hospitals employing physicians, joint ventures of physicians and hospitals and others

31. Significant Details cont’d: • ACO must have “shared governance” (i.e., a governing board) • At least 1 Medicare beneficiary (without conflict of interest) • Optional: community stakeholder • ACO participants must have at least 75% control of board • Outsiders (non-clinicians) can have up to 25% control of board

32. Significant Details cont’d: • ACOs must have: • a manager who reports to the board • full-time medical director • senior executive of ACO • board-certified, licensed physician • “meaningful commitment” by participants: • Financial • Human (time and effort)

33. Legal Issues • Significant Details cont’d: • Assignment of Beneficiaries: • At least 5,000 Medicare beneficiaries • Enough PCPs to service 5,000 patients • By utilization of a “plurality” (not majority) of services from PCP • Retrospective

34. Significant Details cont’d: • Important: each PCP is exclusive to one ACO • Specialists can be in multiple ACOs • ACO can remove, but not add, ACO participants during 3 year term of agreement • ACO must come up with a plan of distribution of savings

35. Legal Issues • Significant Details cont’d: • 2 Models and 2 Tracks for Shared Savings: • Both involve sharing of losses at some point • To get savings, ACO must both: • Report and meet quality measures (65 within 5 domains); and • Achieve cost savings beyond a minimum rate • Disclosure of information to patients: • Patients can seek care from non-ACO providers • ACO must have infrastructure to gather and report data (e.g., IT)

36. PPACA provisions: • More coordinated patient care • Focus on quality and cost savings • Substantial upfront cost e.g., formation of ACOs (IT and other infrastructure, training etc.) • Impact: higher degree of integration in industry • For offensive or defensive reasons (e.g., PCPs)

37. Understanding the Healthcare M&A Marketplace • Contact Information • Michael McLafferty CPA, MBA, CHFP, FACMPE Partner, Healthcare Services Group EisnerAmper, LLP 732-598-8858 Michael.McLafferty@eisneramper.com 37