John R. Washlick, Esquire Buchanan Ingersoll & Rooney PC Two Liberty Place, Suite 3200 50 South Sixteenth Street Philadelphia, PA 19102-2555 215-665-3950.

John R. Washlick, EsquireBuchanan Ingersoll & Rooney PCTwo Liberty Place, Suite 320050 South Sixteenth StreetPhiladelphia, PA [email protected]

The Idaho State Tax InstituteNovember 5-7, 2014

EMERGING TRENDS IN HOSPITAL M&A AND OTHER STRATEGIC AFFILIATIONS POST ACA

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Market Trends

Emerging Trends In Healthcare – Post ACA– M&A– ACOs– Physician Whole-Hospital Ownership – Strategic Partnerships

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Factors Driving M&A

ACA

“Reform will encourage even more consolidation of the industry, as bigger health systems leverage economies of scale and have greater access to credit.”

“Many not-for-profit hospitals, especially single-site and small hospital systems, may struggle.” MOODY’S APRIL 10

“Health reform will likely drive hospital consolidation.” FITCH MARCH 10

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Factors Driving M&A

ACA Influence– The Triple Aim:

Better Care Affordable Care Better Care for the Community

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Factors Driving M&A

ACA Influence– Migration from Fragmented Care to

Coordinated/Integrated Care Models (e.g., ACOs, PCMHs)

– Value-Based Payment Methodologies Favored over Volume-Based Payments (e.g., ACOs, Bundled Payments)

– Individual vs. Population Focus of Care– Payer-Driven Managed Care Shift to Provider-Driven

Accountable Care (Say goodbye to HMOs)– Accelerated Movement To Evidence-Based Medicine – Development and Implementation of EMR

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CMS leaders see ACOs as a historic opportunity and seek “authentic” change

Fragmented care

Coordinated/ Integrated care

Volume-based

payments

Value-based payments

Only treating individuals

Caring for a population

Payer-driven managed

care

Provider-driven accountable care

From To

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Transition to new model may involve multiple contracting approaches …. a new business model

Care Delivery Model Contracting MethodPotential Population

Served

ACO

Risk Sharing/Narrow Network

Full or Shared Risk Contracting

Traditional Medicare

Commercial Payers on Insurance Exchange

Medicare AdvantageCommercial Payers

Core Values:1) Physicians engaged on

quality and cost2) Local, physician-driven

medical management3) Critical mass to pursue best

practices across board4) Deliver value to purchasers

P4P Contracting

Self-insured EmployersDirect Contracting

Integrated Care Model

Commercial Payers

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Market Trends

– Investment Bankers “still” predicting fewer independent hospitals will survive WITHOUT striking some kind of deal with a larger healthcare system

– Booz & Co. study reported most hospital M&A transaction are financially unsuccessful

– Continued investment banker and venture capital interest in 2013– Greater interest by commercial insurers acquiring providers and

creating non-Medicare ACOs

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Factors Driving M&A Credit markets favor larger organizations

0%

1%

2%

3%

4%

5%

-

10

20

30

40

50

Aa A Baa Below Baa

Ope

ratin

g M

argin

(%)

Ope

ratin

g In

com

e (m

illion

s)

Operating Performance by Rating Category

Operating Income Operating Margin

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Factors Driving M&A

Hospitals to integrate . . . .

“Preparations for major reform programs will continue and intensify prior to implementation in 2012 through 2014, and Fitch expects moderate benefits to be realized by many providers through closer integration with medical staffs, enhanced information technology, and improvements in quality and safety.” FITCH JAN 11

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Factors Driving M&A

Declining Patient Volume Capital demands: facilities, technology, and IT Impaired access to capital Compliance with government audits and requirements Increased reimbursement pressures Unfunded pension liabilities Tax-exemption benefits may diminish Economies of scale and increased bargaining power

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Factors Driving M&A

New Service Lines Expand Market Penetration Response to Mounting Competition Non-Financial Factors

– Governance– Cultural Issues – Workforce– Mission

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Desired BenefitsDesired Benefits>Improve access to capital for facilities

and technology >Ensure long term financial viability>Improve managed care contracting>Improve ability to recruit physicians>Add clinical services

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Desired BenefitsDesired Benefits>Ensure easier referrals/consults>Provide better technology access and

care modalities>Gain information technology expertise> Increase back office expertise and

decrease costs>Enhance reputation>Ensure cultural compatibility

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Where does your organization fit in?

ORGANIZATIONAL INTEGRATION OPPORTUNITIES

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Degre

e o

f A

lignm

ent

&

Inte

gra

tion

Partnership ModelsIntegrated

Delivery

Systems

Independent

Hospital

Shared Services

Agreement

Joint Operating Agreemen

t

Local Consolidation/Sa

le

Regional Consolidation/Sa

le

National Consolidation/Sa

le

Clinically Integrated Organizations

Employment Models

Co-Management Agreements

Joint Ventures

Contractual Arrangements

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Hospital Collaboration Models

Holding Company

Sale / Consolidation

Comprehensiveness, Interdependence and Permanency

Sole Corporate

Member Model

Joint Ventures on

Specific Projects

Joint Operating Agreement

Shared Services

Agreement

MoreLess

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Physician Alignment Models

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Physician Practice Lease

Service Contracts; Medical Directorships;Income Guarantees;

Practice Support

Clinically Integrated

PHOs;ACOs

Physician Driven IDS’s

DEGREE OF ALIGNMENT & INTEGRATION

Specialty-Specific

Institutes;Co-Mgmt

Agreements;Bundled

Payments

EmploymentAs a Last

Resort Only

Employment for System-

Aligned Group

Physician Enterprise

Model

Aligned Multi-

specialty Groups

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Choosing the Appropriate Acquisition Model Typical Models

– Non-Profit/Tax-Exempt Parent/Holding Co.– For-Profit Corporation– Limited Liability Company– Captive Professional Corporation– Joint Operating Company

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Choosing the Appropriate Acquisition Model

Non-Profit/Tax-Exempt Parent/Holding Co.– Preservation of 501(c)(3) status– Consider holding company to insulate

assets of parent Methods

– Statutory Merger– Member Substitution– Asset Acquisition

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Choosing the Appropriate Acquisition Model Limited Liability Company

– Corporate protection of limited liability– Can elect to be treated as partnership for federal

income tax purposes– SMLLC of 501(c)(3) is disregarded and activity will be

attributed to single member and activity can be considered tax-exempt without going through the application process set forth in 508(a)

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Choosing the Appropriate Acquisition Model Captive Professional Corporation

– Corporate practice of medicine prohibition – Involving non-licensed individual or entity

– Structure “Friendly Doc” Management Company Shareholders Agreement – restrictions on transfers Stock – Legend citing restriction on transfer Option exercised by management company or its

“licensed designee” Pledge

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Choosing the Appropriate Acquisition Model Captive Professional Corporation

– Consolidated Tax Treatment Field Service Advice Memorandum UIL No. 1502.91-01(April 2005)

– Direct ownership of 1504(a) interpreted to mean “beneficial ownership.” Miami National Bank v. Comr, 67 T.C. 793 (1977)

– FSAM revoked PLR 9605015 (Nov. 8, 1995)– Because putative parent (Health Plan) was

not eligible to employ physicians under PA law, parent not considered “beneficial owner”

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Choosing the Appropriate Acquisition Model Joint Operating Company (They’re Back!)

– Contractual joint ventures and are often referred to as “virtual mergers.”

– The key difference between a JOA and a merger or other type of joint venture is that, in a JOA, there is no change in ownership of assets.

– Also, the governing bodies, and their underlying powers, of the JOA parties do not change

– The central governing body may be organized as a separate legal entity (e.g., nonprofit corporation, LLC etc.) or simply be a contractual arrangement created pursuant to the terms of the JOA.

– Absent a formal corporate structure, the JOC will be treated as a partnership for federal income tax purposes.

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Choosing the Appropriate Acquisition Model Joint Operating Company (They’re Back!)

– If the JOC intends to qualify for 501(c)(3) status it must: Community Benefit -- comply with Rev. Rul. 69-545

(generally applicable to hospitals) Provide charity care “Access” to Emergency Room – Cf. Rev. Rul. 69-545 and

Rev. Rul. 83-157 Conflict of Interest Policy Community Board/Committees Open Medical Staff of Participating JOC Hospitals Integration of Medical and Recordkeeping Systems Medicare/Medicaid Participation

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Choosing the Appropriate Acquisition Model Joint Operating Company (They’re Back!)

– Parties can contribute all their operations or only certain designated services to the JOC.

– A JOC permits the participating parties to operate the combined businesses and distribute profits like any traditional joint venture, all while also accomplishing integration of clinical services for antitrust purposes and avoiding converting tax-exempt bonds from non-taxable to taxable.

– If the parties were to wish to unwind the JOC for some reason, they can more easily be restored to their original positions because they never transferred title to their respective assets to the JOC.

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Choosing the Appropriate Acquisition Model Joint Operating Company (The Devil is in the

Detail)– If the parties do not intend the JOC to

operate long-term, it will be difficult to survive either antitrust or federal income tax scrutiny without real financial or clinical integration.

– The JOC requires a “reconciliation” of operational profits/losses each year and an “equalization” payment between the JOC parties to “even-up.”

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Choosing the Appropriate Acquisition Model

Factors Influencing acquisition model–Assumption of liability–Personal Liability–Corporate Practice of Medicine

Prohibition– Results of due diligence my affect

ultimate model

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Key Deal Points

Show me the $! Fair Market Value and Commercial

Reasonableness Valuations and Appraisals

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Key Deal Points

Valuations and FMV Fact NOT Law Legal Significance

– Tax Tax-Exemption Allocation of Purchase Price

– Fraud and Abuse Stark (FMV v Commercial Reasonableness) Anti-Kickback Statute

FMV v. Commercially Reasonable Review -- Do Not ASSUME Accuracy

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Federal Income Tax Issues

No federal income tax consequence to M&A between two 501(c)(3) organizations – Subchapter C not applicable

Down stream for-profits are affected by M&A between two 501(c)(3) entities

Acquisition of non-profit by for-profit can result in a successor foundation that most likely will be treated (new) or reclassified (old) as a private foundation, UNLESS . . .

Review 501(c)(3) subsidiaries to determine if one can continue public charity status under 509(a)(1) or (2) so resulting foundation

can qualify as a “supporting organization” under 509(a)(3)

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Federal Income Tax Issues

For-profit combinations may defer federal income tax liability under 368(a)(1)

Federal income tax issues will influence whether an acquisition is a stock v. asset and is determined by who is the buyer and the buyer’s risk tolerance to assume liabilities– Capital Gain v. Ordinary Income– Asset Write-Up

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Strategic Affiliation Options

Joint Ventures Joint Operating Company Strategic Clinical Affiliation Clinical Co-Management Strategic Partnership Alliances

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Commercial Payor Affiliations>New Market Models Emerging

o Medicare SSP (e.g., ACO) – Waivers (IRS, OIG, CMS, FTC)

o Non-Medicare ACOs

o Hospital Acquisitions of 501(c)(3) Hospitals by Payors!! -- Highmark Blue Cross

o Physician Practice Acquisitions

o Integrated Delivery Systems

o SUPER Alliances

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HMO/PHO SERVICE DELIVERY ORGANIZATION

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Consolidation to accelerate….

“Reform will encourage even more consolidation of the industry, as bigger health systems leverage economies of scale and have greater access to credit.”

“Many not-for-profit hospitals, especially single-site and small hospital systems, may struggle.”

MOODY’S APRIL 10

“Health reform will likely drive hospital consolidation.”

FITCH MARCH 10

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