During the first physician practice boom in the 1990s, it was common for hospitals to purchase medical practices at inflated prices and then lose money because of misaligned physician incentives. Today, an ever-increasing number of physician practices are owned by hospitals, according to the Medical Group Management Association's 2010 report, Physician Placement Starting Salary Survey. This time around, however, boards are taking a more strategic approach to acquiring and integrating practices into their health systems.

Reform and the discussion of accountable care organizations have made acquiring physician practices a frequent governance issue, and experts advise trustees to explore new operating models to best position their hospitals to deliver accountable care.

While hospitals have become more strategic about acquisitions, evaluating the return on investment of a physician practice hasn't necessarily followed suit. There are multiple layers to analyze and compliance issues to consider when assessing the value a practice brings to a hospital or system. And while it seems counterintuitive, there are some instances in which an acquired practice that loses money still can lead to a winning outcome. To understand why, trustees need to assess the types of loss that can occur with acquired practices. Generally, losses can be categorized into three buckets: strategic, offset and operational.

Strategic Loss

Hospitals have plenty of strategic reasons to purchase practices, such as becoming a leading cardiovascular center or fulfilling a critical part of their mission. A hospital may invest heavily in liver- and heart-transplant programs based on its community's needs instead of developing a more lucrative specialty. In this case, the hospital may acquire a physician practice in order to support this mission.

From a strict cost-benefit analysis, the total revenue generated would be greater if the practice remained independent, because prior to the acquisition, its physicians likely saw very few Medicaid patients. This is considered a strategic-loss situation for the practice and must be weighed appropriately when evaluating the outcomes.

A hospital board also must be cognizant of the federal government's quality standards in order to receive reimbursement. Boards need to understand whether a potential physician practice acquisition can meet existing hospital quality standards and if not, the steps needed to achieve them, often in spite of cost.

Offset Loss

An offset loss often occurs shortly after a hospital acquires a practice. At first glance, the practice may appear to be struggling financially. However, board members must recognize that this loss occurs when revenue sources shift from the practice to the hospital.

It's important to understand the resulting difference in funding (from both the federal government and insurance companies) provided to each party to be able to assess the impact of those changes.

For example, if a physician in northern New Jersey performs a nuclear cardiology service in the office setting, the total Medicare payment is $541.46. If the same service is performed in an outpatient hospital setting, the physician will receive $199.36. And because hospitals incur much higher facility costs than physician offices, Medicare also will reimburse the hospital $1,059.70. (This example is strictly based on cost and revenue information; hospitals likely will take many other factors into consideration, including the impact on customer service.)

In this scenario, the practice revenue will shrink, even though physicians may maintain a consistent rate of productivity. While trustees may be quick to look at the drop-off in the bottom line of the practice, on closer inspection, these patients create higher revenue for the system overall. If the board does not let the practice lose revenue, the hospital will be unable to capitalize on offset dollars.

Operational Loss

While there are 10 areas in which practice losses generally occur, they are most likely to occur when there are inefficiencies in practice operations: productivity, compensation, revenue cycle and staff costs. Visit coding and rent and other overhead also can lead to loss. This usually represents an opportunity to improve the practice margin.

Physician practices also have several opportunities for operational losses; however, there are extenuating circumstances that impact revenue. For example, losses incurred as a result of the physician practice's transition to operating under a health system are expected, especially in the first few months. It may take time to assimilate physicians into working in a hospital environment.

Productivity, and thus revenue, may decrease as physicians get acclimated to new incentive programs and cultural and procedural differences. However, hospitals should examine their physician onboarding programs to see where they may be able to create greater efficiencies, shrink transition time and reduce the loss of revenue.

Two Views of ROI

As health systems ramp up spending on physician practices, it is important for boards to look beyond the practice's bottom line. Losing thousands or even millions of dollars on a physician practice acquisition does not necessarily indicate a bad investment. Instead, trustees must gauge how the acquisition will affect the entire organization.

Being able to categorize losses gives boards an organizing mechanism not only to justify the purchase of a physician practice, but also to determine an accurate return on investment as the practice integrates into the health system in the ensuing years.

To ensure that the acquisition remains a good investment for the health system as a whole, boards must continue to evaluate physician practice losses as strategic, offset or operational.

Rick Carter (rcarter@equationconsulting.com) is CEO of Equation Consulting, Salt Lake City.

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