ABA Health eSource
February 2009 Volume 5 Number 6

Collaboration for Quality - Performance Management Arrangements
By James Pinna, Hunton & Williams LLP, Richmond, VA


Although extraordinarily advanced, the U.S. healthcare system is sometimes ineffective and lacking in quality. In an effort to respond to these issues, governmental and private payors are increasingly aligning payment incentives with improved patient outcomes. Some payors are also reducing payments for hospitals that fail to meet certain quality measures and refusing to pay hospitals for “never events.” Collaboration among hospitals and physicians is essential to achieving quality patient outcomes. One model for collaboration with physicians on quality patient outcomes is the so-called “performance management arrangement” (“PMA”).

PMAs are different from other types of physician collaboration models, such as gainsharing arrangements, hospital syndications, or individual medical directorships. Under a PMA, a hospital will engage a group of physicians to manage clinical care delivery for a service line in exchange for base compensation for services plus performance based compensation tied to the attainment of quality measures. Unlike gainsharing arrangements, PMAs focus on improvement of quality outcomes and do not provide compensation for cost savings. PMAs do not involve physician ownership in the hospital. Additionally, PMAs allow hospitals to engage the entire group of physician stakeholders, as opposed to a single medical director. PMAs can help hospital and physician leader improve patient outcomes, consolidate fragmented administrative duties into a single arrangement, encourage physician stakeholders to collaborate on quality and ensure adequate physician coverage for a service line.

PMAs raise a number of legal issues for hospitals, including potential issues under the Stark Law, 1 the Anti-Kickback Statute 2 and the Civil Monetary Penalty Statute’s 3 prohibition on payments to physicians to induce reductions or limitations of services to Medicare or Medicaid beneficiaries. Private use limitations may also apply to hospitals with tax exempt bonds. 4 This article explores some key issues in structuring PMAs in light of recent guidance from the Centers for Medicare and Medicare Services (“CMS”) and the Office of Inspector General (the “OIG”) of the U.S. Department of Health and Human Services.

Recent Guidance

Acknowledging the benefits of aligning economic incentives to foster high quality and cost-effective care, CMS proposed a new exception to the Stark Law physician referral prohibition in the Medicare Physician Fee Schedule Proposed Rule published on July 7, 2008 for certain incentive payment and shared savings programs. 5 Subsequently, in the Medicare Physician Fee Schedule Final Rule published on November 19, 2008, CMS extended the comment period for an additional ninety days 6 for further comments on this proposed exception. It noted that while properly structured incentive payment programs can meet the requirements of one or more existing Stark Law exceptions (such as the personal service arrangement exception, the fair market value exception, or the indirect compensation exception), the proposed exception provides helpful guidance regardless of which exception is used.

Notably, PMAs typically do not qualify for protection under the personal services and management contracts safe harbor to the Anti-Kickback Statute because quality incentive compensation is not set in advance (as required). 7 The OIG provided guidance regarding quality incentive arrangements in Advisory Opinion 08-16, which determined that a proposed arrangement could be actionable under the CMP and Antikickback statutes if the requisite intent was present, but that the agency wouldn’t impose sanctions in light of the safeguards built into the proposed arrangement. 8 According to the stated facts, a hospital would share with a physician-owned entity certain performance-based compensation available to the hospital under a quality and efficiency agreement with a private insurer

Quality Measures

Both CMS and the OIG have emphasized the importance of appropriate quality measures. CMS included the following features in its proposed exception:

(i) quality measures use an objective methodology, are verifiable and supported by credible medical evidence and individually tracked;

(ii) quality measures are reasonably related to the hospital’s practices and patient population;

(iii) quality measures are listed in CMS’ Specification Manual for National Hospital Quality Measures;

(iv) quality measures are monitored throughout the term of the arrangement to protect against inappropriate reductions or limitation in patient care;

(v) incentive payment establishes baseline levels for the performance of measures using the hospital’s historical data and target levels for quality measures are developed by comparing historical data to national or regional data; (vi) the incentive payment includes thresholds above or below which no payments will accrue to physicians;

(vi) the hospital provides effective prior written notice to patients affected by the incentive payment program; and

(vii) the payment formula is not based on a reduction in length of stay. 9

In Advisory Opinion 08-16, the OIG identified the following features as important safeguards under the Civil Monetary Penalty Statute and the Anti-Kickback Statute:

(i) credible medical support evidencing the potential to improve patient care and avoid adverse effects;

(ii) no incentive to apply a specific standard in medically inappropriate circumstances;

(iii) quality measures are reasonably related to the practices and patient population of the hospital;

(iv) performance measures are clearly and separately identified;

(v) are notified of the quality improvement program; and

(vi) the hospital will monitor the quality measures and their implementation to protect against inappropriate reductions or limitation in patient care. 10

Based on the guidance from CMS and the OIG, it is important for a PMA to have a well-developed quality measure dashboard that allows hospitals to identify and monitor quality measures with reference to historical baseline measures and nationally recognized standards. CMS has pointed towards its Specification Manual for National Hospital Quality Measures 11 as a reference for quality measures, but, depending on the service line involved, many national organizations have developed additional quality measures that hospitals may wish to incorporate. Hospitals should also consider mechanisms that provide for annual updates to quality measures as national quality standards are further developed. With respect to the Civil Monetary Penalty Statute, hospitals should review and monitor quality measures to ensure they do not create an incentive to reduce or limit services to patients. One measure identified by CMS in its proposed exception as potentially problematic is reduction in the length of stay. 12 Additionally, hospitals should consider affirmative covenants in their PMAs that prohibit participating physicians from reducing or limiting services to patients.

Physician Participation

Physicians can participate in a PMA through a variety of structures, depending on the dynamics of the physician stakeholders. For hospitals with a single physician practice providing coverage for a service line, it makes sense to contract directly with that physician practice. When physicians are spread across multiple practices, it is important for the hospital to marshal the cooperation of all physician stakeholders. Potential structures for aligning multiple groups are (i) contract with a single group that independently contracts with other physician participants; (ii) contract with a management company owned by participating physicians; or (iii) create a quality advisory committee composed of physicians who sign individual participation agreements.

There can be significant inertia getting competing physician groups to work together. In some cases the hospital may be able to rely on physicians to establish contractual arrangements or a management company, but sometimes the hospital may need to consider establishing the management company and offering ownership to physicians through a private placement offering. One downside to the use of a management company is the time and cost to create, operate and unwind a separate legal entity. Creating a quality advisory committee involves more contractual arrangements but may help avoid the time and cost of creating and operating a management company.

Regardless of the structure used, there are several features identified by CMS and the OIG regarding physician participation to be considered. CMS included the following features in its proposed exception:

(i) at least five physicians must participate in each performance measure;

(ii) participating physicians must be on the medical staff of the hospital at the commencement of the program and may not be selected in a manner that takes into account volume or value of referrals;

(iii) the hospital must offer the opportunity to participate in the incentive payment program to all physicians in the same department or specialty on the same terms and conditions; and

(iv) payments must be distributed to participating physicians on a per capita basis with respect to each performance measure. 13

In Advisory Opinion 08-16, the OIG identified the following features as important safeguards under the Anti-Kickback Statute: (i) physician participation is limited to physicians who have been on active medical staff for at least a year so to avoid an incentive that would attract new physicians to share in quality compensation and (ii) compensation is distributed per capita to each physician. 14

The physician participation elements outlined by CMS and the OIG are tailored to avoid selective treatment of physicians based on referrals. This compliance concern is heightened when there is an intervening management company or practice group, and hospitals should consider incorporating covenants into agreements to ensure the management company or physician practice operates in a compliant manner.


Developing a compensation methodology that properly compensates physician participants for quality improvement is instrumental to an effective PMA. CMS included the following features related to compensation in its proposed exception:

(i) the arrangement is set out in a signed writing specifying the remuneration in detail sufficient to be independently verified, and includes comprehensive descriptions of the incentive payment program, the applicable baseline measures and the quality targets;

(ii) the term of the arrangement is for no less than one year and no more than three years;

(iii) the payment formula must take into account previous payments for performance measures to ensure that physicians do not receive payment related to quality improvements that were achieved during a prior period;

(iv) the payment formula must be set in advance and not be determined in a manner that takes into account the volume or value of referrals; and

(v) the remuneration paid to participating physicians may not include any amount that takes into account the provision of a greater volume of federal healthcare patient services than the volume provided by the participating physicians during the period of the same length immediately preceding the commencement of the program. 15

In Advisory Opinion 08-16, the OIG identified the following features regarding compensation as important safeguards under the Anti-Kickback Statute:

(i) compensation is subject to a cap tied to the base compensation in the first year such that an increase in patient referrals to the hospital would not result in an increase in compensation to the participating physicians;

(ii) physicians can increase their compensation by achieving quality measures, but not by increasing patient referrals;

(iii) the compensation paid to physicians is based on compensation paid by a private insurer; and

(iv) the proposed arrangement is limited to a three-year contract. 16

In contrast to gainsharing arrangements, which do not lend to a conclusive determination of fair market value, CMS has acknowledged that quality incentive programs can be structured to meet the fair market value requirement contained in other Stark Law exceptions. Hospitals are well served to engage an independent valuation expert to help determine fair market value compensation for a PMA. Base compensation for work effort can often be determined by reference to a fair market value hourly rate. The base compensation should be based on delineated management duties that can be substantiated with time studies from physician participants. Hospitals may find it preferable to pay base compensation for actual hours worked, rather than a fixed monthly amount, but hourly compensation may preclude fitting squarely within a Revenue Procedure 97-13 safe harbor, as discussed below. Quality incentive compensation should be distributed per capita, but hospitals may want to consider whether it is more appropriate to distribute base compensation per capita or based on individual work effort.

The formula for calculating quality compensation should be clearly spelled out in the PMA. Quality incentive compensation can often be evaluated in the context of reimbursement provided by third party payors for achieving quality targets, as well as the potential cost associated with a hospital separately employing or engaging a manager to achieve comparable quality without the assistance of participating physicians. While service line revenues may be relevant in determining the maximum quality incentive compensation available (e.g., determining the amount of incentive compensation available from third party payors who pay quality incentives based on percentage of net revenue), quality incentive compensation should not fluctuate based on increases or decreases in service line revenues (which may relate to referrals). Hospitals may also want to consider allocating quality compensation or “quality points” to each quality measure based on its relative importance.

Quality points should only be earned if participating physicians are able to meet the quality target identified or show demonstrable improvement from the historical baseline measures. Bonus compensation could also be considered for scoring above quality targets. CMS has indicated that the quality incentive formula should take into account previous payments for performance measures to ensure physicians do not receive payment related to quality improvements already achieved. One way to alleviate this concern is to annually review and update quality targets based on nationally recognized measures.

Private Use

A management contract involving a hospital with tax exempt bonds can potentially result in private business use if the contract provides compensation based, in whole or in part, on the net profits from the operation of the hospital. 17 To avoid private business use, the compensation provided to participating physicians under a PMA should be reasonable compensation not based on a share of net profits. Revenue Procedure 97-13 states that compensation based on a per-unit fee is generally not considered based on net profits. An hourly rate is considered a per-unit fee, but a quality incentive fee does not squarely fit within the definition of per-unit fee because it is not based on a unit of service. However, properly structured quality incentive fees can avoid being characterized as a share of net profits as evidenced by the Internal Revenue Service in certain non-binding private letter rulings involving similar quality incentive fees. 18

Although compliance with Revenue Procedure 97-13 is not mandatory (unless required under bond covenants), it outlines several safe harbor arrangements where a management contract will not result in private business use. PMAs generally cannot fit within the safe harbor for percentage of revenue arrangements (because of the potential linkage to referrals) or per-unit fee arrangements (because quality compensation is not a per-unit fee). The most applicable safe harbor is the fifty percent periodic fixed fee arrangement, which requires fifty percent of the compensation to be a stated dollar amount for services rendered for a period of time. Additionally, the term of the contract cannot exceed five years and must allow for termination by the hospital on reasonable notice, without penalty or cause, at the end of the third year. To meet the fifty percent periodic fixed fee safe harbor, the base compensation under the PMA must be a fixed amount equal to or greater than the available quality incentive compensation. Hourly fees are unlikely to be considered a periodic fixed fee, so hospitals attempting to use this safe harbor will need to carefully review the time obligations of physician participants and ensure such time obligations are being met to avoid overcompensation.


In light of the increasing demand on hospitals to deliver quality patient outcomes in order to receive full, or enhanced, reimbursement for healthcare services, hospitals may want to consider PMAs, along with other structures, as a strategy for collaborating with physician stakeholders to improve patient care. PMAs implicate a number of legal issues, and hospitals are well served to closely review the recent guidance from CMS and the OIG with their legal counsel and valuation experts when structuring PMAs.

1 42 U.S.C. § 1395nn.
2 42 U.S.C. § 1320a-7b(b).
3 42 U.S.C. § 1320a-7a(b).
4 26 U.S.C. § 145(a)(2) & 141(b).
5 73 Fed. Reg. 38502, 38548 (July 7, 2008).
6 73 Fed. Reg. 69726, 69793 (November 19, 2008).
7 42 C.F.R. § 1001.952(d).
8 OIG Advisory Opinion No. 08-16 (October 7, 2008).
9 See note 5.
10 See note 8.
11 The Specifications Manual for National Hospital Quality Measures is the result of the collaborative efforts of the CMS and The Joint Commission to publish a uniform set of national hospital quality measures, and is available at this link.
12 See note 8.
13 See note 5.
14 See note 8.


See note 5.
16 See note 8.
17 26 C.F.R. § 1.141-3(b)(4)(i).
18 Priv. Ltr. Rul. 9823008 (February 27, 1998); Priv. Ltr. Rul. 200330010 (April 17, 2003).


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