January 21‚ 2010

Payment Reform—A Catalyst for Increased M&A Activity

By Thomas S. Crane and Stephen M. Weiner

The pending federal health care reform legislation includes Medicare reform proposals that are designed to improve the quality and efficiency of care and provider accountability while also reducing overall costs. The recent special Senatorial election in Massachusetts leaves the enactment of health care reform legislation this year in considerable doubt. Even if no legislation is enacted, it is nevertheless worth considering the possible effect of proposals for payment reform and the development of provider networks—referred to as “accountable care organizations” (ACOs)—on M&A activity. A major manifestation of this policy reorientation is found in the proposals for mandated demonstration and pilot projects and studies that are contained in the House and Senate health reform bills. Both bills contain extensive provisions aimed at moving Medicare, and eventually perhaps the payment mechanisms for other payors throughout the health care system, toward payment policies intended to promote value, efficiency and quality and away from fee-for-service-based reimbursement. Even if these proposals are not enacted as part of comprehensive reform legislation, less far-reaching federal legislative initiatives, potential regulatory activity by the Centers for Medicare & Medicaid Services, parallel initiatives at the state level (such as the proposal for payment reform and ACO development under consideration in Massachusetts), and private payor initiatives all seem to be leading in the same direction.

This advisory describes the provisions contained in the pending bills as examples of the kinds of approaches that may be expected, regardless of the outcome of comprehensive reform legislation at the federal level. As noted above, we believe that an increase in M&A activity and anticipated industry consolidation will occur regardless of the fate of that legislation.

Value-Based Purchasing

The Senate bill provides for the Secretary of the Department of Health and Human Services (the Secretary) to phase in a separate “value-based payment modifier” to the physician payment fee schedule. This payment modifier would provide for differential payments to physicians or groups of physicians based upon the quality of the care that they achieve for Medicare beneficiaries relative to the cost of that care. The modifier would be in addition to the existing geographic adjustment factors, and is intended to promote “systems-based care,” take into account the special circumstances of rural and other underserved areas, and be implemented in a budget-neutral manner.

Provisions with a similar focus that appear in the House bill are more ambitious. Those sections seek value-based reimbursement changes for all of Medicare Parts A and B. This part of the House bill starts by directing the Institute of Medicine (IOM) to study the underlying reasons for existing geographic variations in cost and the growth in the volume and intensity of services, adjusting for graduate medical education and disproportionate share payments. Among the recommendations the House bill would expect of IOM include ones relating to the quality and cost of care, potential reductions in the fragmentation and duplication of services, promotion of “evidence-based medicine,” and the feasibility of creating a “value index,” a composite of quality and cost factors intended to allow for adjustments to provider rates on a regional or provider-level basis. The use of a “value index” is intended to promote “high value care”—that is, “the efficient delivery of high quality, evidence-based, patient-centered care.” Recognizing the complex politics associated with major Medicare payment reform, the House bill provides that the IOM recommendations would be submitted to the Secretary and Congress by April 2011 and the Secretary would review the recommendations and, based on that review and input from other sources, would then submit a detailed payment reform implementation plan to Congress. Congress would have only a limited right, under detailed streamlined procedures, to pass a joint resolution of disapproval, subject to a Presidential veto.

Accountable Care Organizations

Another Congressional attempt to promote cost savings and quality involves the ACO model designed to test different payment incentive models within structured provider networks. The Senate bill proposes only a pediatric ACO demonstration project and a new Medicare “shared savings program” (also known as gainsharing). The House takes a more complete approach by proposing to authorize a Medicare ACO pilot program to provide incentive payments based on attaining documented costs savings and established quality benchmarks. The House’s model would encompass pilot ACOs, consisting of groups of physicians or physician organizations, hospitals and other providers that would provide services using incentive payment methodologies, including a so-called “performance target model” and “partial capitation model.” Under any of the incentive payment models, qualifying ACOs would need to meet quality benchmarks, and the payments would be implemented in a budget-neutral manner for Medicare. The House bill, then, weds elements of payment reform with expected industry restructuring to produce provider networks capable of assuming increased levels of financial risk.

As noted earlier, similar initiatives are under review or are being initiated by states and private payors.

Implications for the Market

The inclusion of these value-based or ACO provisions in the proposed federal legislation has been the subject of quiet, and sometimes not so quiet, celebration by certain hospital systems that believe that “paying-for-value” and ACO arrangements will benefit them by eventually shifting a greater percentage of Medicare dollars to so-called “high value” hospitals and “accountable” systems and away from their “less efficient” peers. The desire on the part of some providers to promote this effect, when taken with state and private payor initiatives around payment reform and ACO formation, have led us to conclude that, even if federal health legislation goes nowhere, now is the time to start planning for these changes. Private pilot programs have already started, or are in the planning stages, to test evidenced-based and value-based payment arrangements, as well as accountable care models. We anticipate that providers will continue this momentum in the hope of capturing some of the benefit of being first-to-market.

Given the expected changes in the landscape resulting from these reform initiatives, hospital systems and physician organizations are likely to expand in a manner reminiscent of the banking and financial services industry in the last few decades. Providers that can convincingly demonstrate that they furnish high-value care may be expected to set their sights on strategic target acquisitions where they can expand their models into new geographic areas and additional communities. Those hospital systems that find themselves on the other side of this value proposition will need to plan for a reduced allocation of federal dollars, investigate alternative revenue streams or cost cutting measures, or enter into affiliations (which may be characterized as ACOs) with those more efficient providers who will be the likely “winners” in the new reimbursement world.

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