Surgicenter Outside the Harbor, But Still Safe

Action Kit

November 2001

In May the IRS gave hospitals guidance on how to structure a hospital-physician joint venture surgicenter that does not jeopardize the hospital's tax-exempt status. (See the June 2001 issue of ACTION KIT for a discussion of this IRS private letter ruling.)

Now the OIG has chimed in on how to structure such arrangements without running afoul of the fraud and abuse laws. It is interesting that the OIG begins its analysis by stating that it "recognizes that precluding joint ownership of ASCs [ambulatory surgery centers] may place hospitals at a competitive disadvantage by forcing them to compete with ASCs owned by physicians, who principally control referrals."

In Advisory Opinion 01-17, issued on October 17, 2001, the OIG determined that it would not impose sanctions on an ambulatory surgical center joint venture, even though the arrangement did not fit squarely within the safe harbor for hospital/physician surgicenters issued by the OIG in November 1999. While it is important that such joint ventures and any ancillary arrangements (in this case there was a lease and medical director contract) be carefully structured to minimize fraud and abuse concerns, this advisory opinion indicates that, as long as income related to such a venture, whether investment, rental or for services rendered, is reasonable and is not tied to referrals, such arrangements will pass OIG muster.

The joint venture at issue in Advisory Opinion 01-17 was a freestanding eye surgery center that was owned, through holding companies, by a hospital and two groups of ophthalmologists. Each group owned a limited liability corporation (LLC). Those two LLCs in turn owned a third LLC. The third LLC and a hospital-owned entity were the actual investors in the joint venture.

The hospital owned 25% of the venture, while the ophthalmologists collectively owned 75%. The return on investment to the hospital and each investing ophthalmologist was "directly proportional to the amount of capital that the applicable investor contributed to the respective holding company compared to the total capital contributions to the Surgical Center from all investors." (Under the latest guidance from the IRS, the return on investment to the hospital would be considered unrelated business income and would be taxable since the hospital did not control the joint venture.)

Physician Investors

The ophthalmologists certified that "(i) the terms on which the investment interests in the three limited liability companies were offered to the Investing Ophthalmologists were not related to the previous or expected volume of referrals, services furnished, or business otherwise generated to or for the Hospital or the Surgical Center; and (ii) none of the capital contributed by the Investing Ophthalmologists was obtained with funds loaned or guaranteed by the Surgical Center, any direct or indirect investor, or any individual or entity acting on behalf of the Surgical Center or any direct or indirect investor."

Each ophthalmologist agreed to notify patients who were referred to the ambulatory surgery center of the ophthalmologists' and hospital's investment interests in it. Finally, each ophthalmologist met the "one-third practice income" test, meaning that "each physician investor's medical practice income from all sources for the previous fiscal year or previous 12-month period was derived from the physician's performance of procedures."

Just Outside the Safe Harbor

For an ambulatory surgery center owned by a hospital and physicians to fall within the safe harbor (42 C.F.R. §1001.952(r)(4)), it must meet the following eight standards:

"(i) The terms on which an investment interest is offered to an investor must not be related to the previous or expected volume of referrals, services furnished, or the amount of business otherwise generated from that investor to the entity.

"(ii) The entity or any investor (or other individual or entity acting on behalf of the entity or any investor) must not loan funds to or guarantee a loan for an investor if the investor uses any part of such loan to obtain the investment interest.

"(iii) The amount of payment to an investor in return for the investment must be directly proportional to the amount of the capital investment (including the fair market value of any pre-operational services rendered) of that investor.

"(iv) The entity and any hospital or physician investor must treat patients receiving medical benefits or assistance under any Federal health care program in a nondiscriminatory manner.

"(v) The entity may not use space, including, but not limited to, operating and recovery room space, located in or owned by any hospital investor, unless such space is leased from the hospital in accordance with a lease that complies with all the standards of the space rental safe harbor...; nor may it use equipment owned by or services provided by the hospital unless such equipment is leased in accordance with a lease that complies with the equipment rental safe harbor... and such services are provided in accordance with a contract that complies with the personal services and management contracts safe harbor....

"(vi) All ancillary services for Federal health care program beneficiaries performed at the entity must be directly and integrally related to primary procedures performed at the entity, and none may be separately billed to Medicare or other Federal health care programs.

"(vii) The hospital may not include on its cost report or any claim for payment from a Federal health care program any costs associated with the ASC (unless such costs are required to be included by a Federal health care program).

"(viii) The hospital may not be in a position to make or influence referrals directly or indirectly to any investor or the entity."

The surgery center in this case met all of the requirements except the last one. Because the hospital employed a number of physicians and had affiliations or arrangements with certain others, it was in a position to refer to both the ambulatory surgery center and the individual ophthalmologist investors. To address that "breach" of the safe harbor, the hospital certified that it would implement the following safeguards and would notify all hospital-affiliated physicians of the safeguards on an annual basis:

"• Physicians employed by the Hospital will not make referrals directly to the Surgical Center, although they may refer patients to the Investing Ophthalmologists or their group practices.

"• The Hospital will refrain from taking any actions to require or encourage Hospital-Affiliated Physicians to refer patients to the Surgical Center, the Investing Ophthalmologists, or their group practices.

"• The Hospital will not track referrals made by Hospital-Affiliated Physicians to the Surgical Center, the Investing Ophthalmologists, or their group practices.

"• Compensation paid to Hospital-Affiliated Physicians, whether pursuant to employment or personal services contracts, will not be related directly or indirectly to the volume or value of referrals or other business generated by such physicians to or for the Surgical Center, the Investing Ophthalmologists, or their group practices. Such compensation will be consistent with fair market value in arm's-length transactions."

The OIG found that these safeguards would significantly restrict the hospital's ability to direct or influence referrals to the surgery center. It likewise determined that, although the ophthalmologists' investment through limited liability companies, rather than directly, also put this joint venture outside the safe harbors, "the use of the ‘pass through' companies rather than direct ownership [did] not substantively increase the risk of fraud and abuse."

Lease and Medical Director's Agreement

The ophthalmology surgery center is located in space owned by the hospital. The hospital's outpatient endoscopy lab is in the same location. The surgery center leases a surgical suite and an adjacent reception area from the hospital. It then leases back half of the reception area to the hospital for use as a reception area for the endoscopy lab. There are separate receptionists for the surgery center and the endoscopy lab. Lease payments are consistent with fair market value and the arrangements meet all of the other requirements in the space rental safe harbor.

One of the ophthalmologists serves as medical director for the surgery center. This requires three to four hours per week. The medical director keeps a daily log and is compensated on an hourly basis. There is a monthly cap on how much he can be compensated. The hourly rate is at fair market value. The OIG found that, although this arrangement too falls outside the personal services safe harbor because the aggregate compensation paid over the term of the contract is not specified in advance, the risk of fraud and abuse is significantly reduced by requiring written documentation of hours worked, a fair market hourly rate, and a monthly cap.

New Competitive Strategies

Aside from showing how to set up a hospital-physician surgicenter without running afoul of the kickback law, this Advisory Opinion is instructive on two key points. First, by focusing on hospital-employed and affiliated physicians as referral sources, it seems to tacitly accept the premise that the hospital itself does not refer patients to the surgicenter. This is critical since a contrary view could lead one to conclude that a hospital could never participate in a joint venture surgicenter in its service area.

Second, and even more important, the OIG recognized that hospitals are at a disadvantage when competing with physician-owned ASCs. Given the financial incentive to refer to the surgicenter (and thus take business away from the hospital) inherent in physician ownership, hospitals need to adopt new competitive strategies, some of which may place them at odds with members of their medical staffs.

One strategy is a joint venture, but others, such as competing for exclusive managed care contracts and restricting the medical staff prerogatives of physicians with competing interests, may be even more effective. The acknowledgment by the OIG that physician ownership of ASCs tilts the competitive playing field in favor of the physicians will go a long way to support the legitimacy of reasonable competitive moves by hospitals.