Is it Time to Resurrect Physician Practice Management Organizations?

The introduction of President Obama's healthcare reform plan has once again stirred debate about how to move healthcare delivery into the future. The outcome of reform remains unclear, however a likely outcome is that physician reimbursement and compensation will continue to shrink for all specialties, and that any reform model enacted will result in a healthcare delivery system that will make smaller payments to physicians per increment of service provided.

The winners in the new system will be physicians who effectively collect patient data through an electronic medical record system, can demonstrate quality, and have the tools to seize control of a larger share of the healthcare dollar. Physician organizations with little access to capital, professional management, and data will lose out to practices that have access to current technology as a result of better capitalization and management.

In the healthcare delivery system of the future, it is anticipated that virtually all physicians will either be employed by hospitals or part of a large consolidated physician group. With rare exceptions, physicians will not be able to consolidate into large groups without assistance from business and capital partners. These environmental changes could create an opportunity for the resurgence of the physician practice management, or PPM, model.

What Is the Physician Practice Management Model?
Historically, many states have prohibited non-physicians from having ownership interests in physician practices through Corporate Practice of Medicine Statutes. As a result, physician practices have not had the same access to capital or business acumen as other healthcare businesses. The practice management model simply brings these advantages to bear on physician practices in a manner that is compliant with state corporate practice of medicine statutes.

In the typical model, a physician practice management company (the PPM) acquires all of the tangible assets, other than real estate, associated with a physician practice. The PPM then employs all of the personnel associated with the practice other than the physicians and certain clinicians who, under applicable state law, must be employed by the practice. The PPM provides all of the personnel and assets necessary to operate the practice in exchange for a management fee that includes reimbursement of the PPM's costs. In this regard, the PPM functions primarily as a capital partner to provide the capital necessary for the practice to expand, invest in ancillary services and information technology (including an electronic medical record system), and/or consolidate a market. The capital, plus interest, is repaid to the PPM through a management agreement.

The PPM runs the day-to-day business operations of the practice, and physicians are solely responsible for the clinical aspects. Each physician typically has an employment agreement with the practice that includes non-competition and non-solicitation provisions, to the extent they are permissible by law. Many states have statutes or case law that limit the enforceability of physician non-competes. The laws of each state must be analyzed to determine whether any non-compete is enforceable.

The PPM is paid a management fee in addition to being reimbursed for its costs. The amount of the fee depends upon the structure of the relationship, as well as the services provided by the PPM. In the original practice management model, the PPM also acquired, in exchange for a fair market value purchase price and to be paid as part of its management fee, a percentage of the profits of the practice before physician compensation ("Profit Share"). The Profit Share structure included in the first generation of physician practice management arrangements is the principal reason the industry failed.

Why the Industry Failed in the Past
In the late 1980s and early 1990s, first-generation physician practice management companies like PhyCor and MedPartners used a model in which the typical management fee consisted of the following:

1. Reimbursement of the PPM's cost of providing the assets and personnel to the practice
2. Profit Share of 15% of the practice's profit before physician compensation
3. Up to 50% of any profits recognized by the practice as a result of new ancillary services financed by the PPM and any "profit" resulting from capitated HMO products.

The PPMs not only paid the practice for the tangible assets acquired and, in effect, leased them back to the practice through the management agreement, but also paid the practice a multiple of projected Profit Share. A portion of the purchase price was paid at closing, and the balance was typically paid over a two- to three-year period to prevent any decline in physician compensation during that time.

The model assumed that the overall profitability of the practice would grow under the revised management structure so that the physician's compensation would not decline even after payment of the Profit Share. The assumption of practice profitability growth was initially built on the theory that all healthcare expenditures would ultimately be on a capitated model. However, the healthcare delivery system did not, except in California, evolve to a capitated model.

In addition, physician productivity often decreased after the practice sold out to the PPM. As a consequence, physicians saw a substantial decline in income after the income supplements had been paid, and the practices were not only unable to retain existing physicians but had a competitive disadvantage in recruiting. As a result, the PhyCor and MedPartners model failed.

What Have We Learned?
First and foremost, it is clear that a model that decreases physician compensation, absent an increase in profitability of the physician practice, is not a viable long-term strategy. . The model must be, at a minimum, cost neutral to the practice and the incentives of the PPM and the practice must be aligned. In the first generation of physician practice management models, the PPM did not provide any true centralized revenue cycle management function or materials management/group purchasing function. Under the new model, the PPM must provide these services.

Instead of the PPM receiving a Profit Share as a component of the fee, the fee could be based on a percentage of net revenues that is equal to the cost savings to the practice from the PPM providing revenue cycle management, materials management, reductions in salary and wages, and benefits costs. The management fee should also allow the PPM to share in the incremental profits recognized by the practice, other than from providing professional services. The PPM will continue to be reimbursed for costs and capital incurred on behalf of the practice.

What Are the Opportunities?
There are a number of profit opportunities that can be driven through the consolidation of a substantial number of physicians into a large physician group that has significant market share in a given region. Opportunities for physician groups include: (i) controlling and profiting from the revenue streams, (ii) improving revenue streams through demonstrated quality, (iii) development and commercialization of protocols, (iv) disease management, (v) clinical trials and genetic testing, (vi) pharma economics, (vii) developing and operating employer clinics, and (viii) developing enhanced ancillary services.

In order for physician practice management organizations to rise from the ashes there will, however, have to be sufficient returns on the capital invested in the physician practice management company. Whether there are sufficient returns in a broad-based physician practice management company remains to be seen. Early results in companies that focus on a segment of the opportunity (e.g., employer clinics, enhanced ancillary services, disease management and billing and collection) have been promising, and logic dictates that combining those revenue models with a critical mass of physicians who can exercise market power can be profitable.

Investors will, however, have to appreciate the differences in the opportunity, as well as key differences in the model, to move past the physician practice management failures of the past. Whether investors can do so remains to be seen.