June 2011 Volume 7 Number 10

Co-Management Agreements, Compensation & Compliance

By Jen Johnson, CFA, VMG Health, LLC, Dallas, TX

AuthorHospitals’ critical success factors are shifting towards quality performance benchmarked to national standards. This trend towards improved quality is increasing the need for hospitals to align with physicians since they control the delivery, management, and utilization of clinical services. As a result, many hospitals are involving physicians in various types of service arrangements, such as co-management agreements.

It is important to understand that compensating physicians for assisting in the attainment of high quality care must be set at Fair Market Value (“FMV”) and that the terms of the arrangement must be consistent with regulatory guidelines. Failure to do so could result in criminal and/or civil penalties based on healthcare fraud and abuse laws. The following provides an overview and regulatory guidance associated with paying for quality care and specifically addresses co-management agreements.

The Trend - Paying for Quality

Governmental and commercial pay for performance (“P4P”) programs indicate that compensating hospitals for quality care is becoming more common. Perhaps the most relevant regulatory support related to paying for quality care is based on CMS’ P4P pilot project, the Hospital Quality Incentive Demonstration (“HQID”) Program. In 2003, CMS started financially incentivizing hospitals for quality through this P4P program which was launched by CMS and Premier Inc.1 HQID includes more than 250 hospitals which are measured on more than 30 standardized and widely accepted care metrics for patients in six clinical areas – heart attack, coronary bypass graft, heart failure, pneumonia, hip and knee replacements, and the Surgical Care Improvement Project.2, 3

There is not yet a nationwide CMS P4P program; however a CMS national Value Based Purchasing (“VBP”) program is expected soon. On January 7, 2011, CMS released a proposed rule establishing the VBP program which would be mandated under Section 3001 of the Patient Protection and Affordable Care Act (“PPACA”). It is anticipated that the new program will provide value-based incentive payments to hospitals beginning in Fiscal Year 2013, based on their achievement or improvement on a set of quality care measures.4 Similarly, Accountable Care Organizations (“ACOs”), mandated under Section 3022 of PPACA are expected to provide financial incentives for quality outcomes; the proposed rule implementing this provision was published April 7, 2011.5 Finally, history has shown that commercial payors are influenced by governmental initiatives and that the entire industry will most likely continue to see growth in commercial payor P4P programs.

Quality Incentives Work if Implemented Correctly

Research shows P4P programs are effective at improving quality. The majority of hospitals involved in the HQID project, even those on the lower end of the scale, improved their quality of care across the board. The most recent HQID results show that hospitals raised overall quality for the metrics noted above by an average of approximately 18 percent over five years.6 Another pilot program, sponsored by the Robert Wood Johnson Foundation and California HealthCare Foundation, tested the use of financial incentives to improve the quality of healthcare. Results conclude that financial incentives motivate change, and alignment with physicians is a key factor to improving quality.7

Although the majority of studies show these programs work, they are not foolproof. Quality programs may fail when payments are made to physicians without any measurable improvement in quality. The structure, implementation plan, and compensation parameters must be defined upfront to ensure the physician payments are linked to actual improvement or superior outcomes.

Regulatory Guidelines Related to Paying for Quality

  • Once the hospital and physicians have decided to collaborate to improve quality, processes for implementing and monitoring the agreement between the two parties will be the key to success and compliance. The following is a summary of pertinent regulatory guidelines to financially incentivizing quality care8
    Quality measures
    • Should be clearly and separately identified.
    • Should use an objective methodology which is verifiable and supported by credible medical evidence.
    • Should be reasonably related to the hospital’s practice and consider the patient population.
    • Physician and hospital input in choosing metrics should be documented.
  • Incentive payments
    • Should consider the hospital’s historical baseline data and target levels developed by national benchmarks.
    • Thresholds should exist where no payment will accrue.
    • Should be based on Fair Market Value and not consider the value and volume of referrals.
  • The program
    • Patients should be notified of the program.
    • Ideally will be offered to all applicable providers.
    • Hospital should monitor program to protect against reduction in patient care.

It is clear that in addition to the payments, the terms of the arrangement will need to be carefully developed if a healthcare organization is considering paying for quality care. There are various types of quality incentive arrangements in the market, all of which should consider the guidelines above. The following addresses one of the most popular arrangements for hospitals to incentivize physicians to assist them with quality outcomes, co-management agreements.

Co-Management Agreements

Co-management agreements are a direct result of the growth in P4P programs and are most often structured as a fixed fee for services rendered by physicians, and a variable fee based on a hospital’s quality outcomes. These arrangements do not typically include metrics related to cost savings or gain sharing. In addition, they allow for physicians and hospitals to align without having to form a new joint venture. The most common co-management agreement structure provides physicians with a fixed fee based on services related to improving quality and a variable fee based on quality outcomes. According to a PriceWaterhouseCoopers Physician Employment Survey, 24 percent of physicians are currently engaged in a co-management arrangement and 51 percent of physicians are interested in pursuing this type of arrangement over the next 2 years.9

These arrangements are typically associated with both service lines of hospitals and hospital- owned outpatient departments (ambulatory surgery centers). The following addresses some fundamental topics discussed among healthcare executives, attorneys, consultants, and valuation firms when developing these arrangements:

  • Fee Structure - Regulatory guidelines require that payments to physicians be set at FMV. In order to document an arrangement is at FMV, understanding the services being provided per the agreement and resulting quality outcomes will be essential. Therefore, determining the FMV compensation for such an arrangement should be assessed after an agreement has been drafted and services have been outlined. This is due to the fact that compensation structures and services provided may vary among these agreements. Ideally, the FMV analysis will reflect the services and structure as exactly outlined in the agreement.
  • Quality Metrics - Once the structure has been defined, a significant amount of due diligence should be involved with choosing the appropriate quality metrics since the resulting outcomes will be the driver for the variable fee. The selection of the metrics should be based on a joint effort between the hospital and physicians. This will demonstrate a coordinated effort between the two parties (co-managed) and assist in ensuring the measures will be reasonably related to the hospital’s practice and consider the patient population.
  • Benchmarking - A fundamental step to incentivizing quality care requires understanding what defines superior quality. As discussed previously, regulatory guidance suggests that when incentivizing for quality care, the quality measures should be individually tracked and use an objective methodology which is verifiable and supported by credible medical evidence. Specifically, it is prudent that quality targets be developed by, and measured against, national benchmarks. At the very least, hospitals should understand the average or median, and top or 90 th percentile performance. This will allow the hospital to understand what constitutes both improvement and superior quality outcomes.
  • Historical Performance – As addressed previously, regulatory authorities have also stipulated that incentive payments should take into account the hospital’s historical baseline data. If a hospital wishes to provide financial incentives for improvement in quality, understanding historical performance is the only way to support that improvement was actually achieved. Another reason to consider historical performance is to ensure that a portion of the chosen metrics reflect areas that need improvement.
  • Legal Guidelines - It is critical that healthcare executives are able to both explain the reasons for developing a co-management arrangement and defend the compensation stated in the agreement. Adhering to regulatory guidance with co-management arrangements has proven to be challenging among hospitals. These arrangements are still relatively new, making structure and fee decisions more complicated due to lack of industry standards. It is important to step back once the terms and compensation of an arrangement are outlined and ask yourself if it makes sense based on the economics and the hospital’s mission, without considering referrals.

Bottom Line

Based on the growth of P4P programs and regulatory guidance, paying for quality care appears to be the way of the future. If a healthcare organization is considering implementing a co-management agreement, understanding the regulatory guidelines surrounding these arrangements is as important as ensuring the payments are set at FMV. Both the terms of the agreement and the analytical process for determining the payments will be essential in defending the arrangement before regulatory authorities.

This article is not to be construed as legal advice.

Jen Johnson oversees the valuation of professional service arrangements at VMG Health, LLC, a national health care transaction and advisory firm in Dallas, Texas. Prior to that she was a finance professor at the University of North Texas and worked in a national consulting firm’s litigation department. She may be reached by e-mail at JenJ@vmghealth.com or by telephone at 214/369-4888.


Premier, Inc. is a healthcare alliance made up of approximately 200 hospital, health systems, and providers that aims to improve the health of communities through nationwide knowledge in the local healthcare setting. Premier collects and analyzes clinical and financial data from its member hospitals, sponsors seminars and conferences, and shares best practices in an effort to drive improvement in quality and reduction in costs.

Source: http://www.premierinc.com/about/mission/index.jsp

2 Quality-based payments: Incentives and disincentives for improvement, Health Care Compliance Association Magazine, page 20. November 2008.
3 CMS Press Release 12/9/10. http://www.cms.gov/HospitalQualityInits/35_HospitalPremier.asp
4 No Time to Waste, CMS Publishes Rule for Hospital Value Based Purchasing Program, Spencer Healthcare Strategists, January 2011. http://www.shstrategists.com/2011/01/articles/qualityvaluebased-purchasing-1/no-time-to-waste-cms-publishes-proposed-rule-for-hospital-valuebased-purchasing-program/

ACO Proposed Rule , CMS, April 7, 2011. http://www.gpo.gov/fdsys/pkg/FR-2011-04-07/pdf/2011-7880.pdf


CMS Releases Results of Pay-for-Quality Demonstrations, December 13, 2010, http://community.advanceweb.com/blogs/al_4/archive/2010/12/13/cms-releases-results-of-pay-for-quality-demonstrations.aspx


Rewarding Results: Aligning Incentives with High-Quality Health Care, Robert Wood Johnson Foundation. Health Care Manager: April/June 2008 - Volume 27 - Issue 2 - pp 104-112.


Advisory Opinion 08-16: http://oig.hhs.gov/fraud/docs/advisoryopinions/2008/AdvOpn08-16A.pdf

National Law Review: http://www.natlawreview.com/article/gainsharing-finally-here-to-stay-recent-advisory-opinions-and-propo

McDermott Will & Emery: http://www.mwe.com/info/news/wp0708c.pdf

MedPAC: http://content.healthaffairs.org/content/25/2/413.full


Weekly Tidbits and Takeaways, Morgan Stanley, Healthcare Facilities/Related Services, January 3, 2011.

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