Do-It-Yourself Valuation: When and How to determine Fair Market Value Without an Outside Appraiser

Vol. 10 No. 3

Untitled Document

AuthorA. Introduction – The Need for Do-It-Yourself Appraisals

The sheer volume of transactions that implicate the federal healthcare laws is staggering. Couple that with the fact that healthcare law requires remuneration in those transactions to be consistent with “fair market value” (or “FMV”),1 it gives rise to the logistical problem of how to accurately and consistently determine FMV for so many transactions. Further complicating the picture is the fact that determining FMV is anything but intuitive and straightforward.2 At larger healthcare entities, such as hospitals or pharmaceutical and device companies, much of the work of determining FMV is handled internally out of sheer necessity. For these situations, this article addresses the challenges and best practices for the “do-it-yourself” (or “DIY”) valuations that are simply an unavoidable fact of life.

B. Determining FMV for Healthcare Transactions is Difficult

Determining FMV is no picnic, and any guidance provided by the government is limited and somewhat vague, at best. The key passages of the Stark regulations and associated commentary that define FMV3 state that it is purposely different from the IRS version of the FMV standard,4 and provide fairly vague and disjointed guidance on how to determine FMV over numerous separate pronouncements.5 On the one hand, the guidance suggests that parties may use “any reasonable method” to determine FMV.6 On the other hand, the commentary indicates that FMV is defined in a way that limits the ability to use traditional methods that are used in the IRS context.7 Furthermore, in the Stark commentary CMS made it clear that DIY valuations are allowed, stating:

We agree that there is no requirement that parties use an independent valuation consultant for any given arrangement when other appropriate valuation methods are available. However, while internally generated surveys can be appropriate as a method of establishing fair market value in some circumstances, due to their susceptibility to manipulation and absent independent verification, such surveys do not have strong evidentiary value and, therefore, may be subject to more intensive scrutiny than an independent survey.8

Therefore, while the government guidance clearly indicated a preference for independent third-party appraisals, whenever possible, CMS recognized that it is plainly not feasible to require independent appraisals in all cases. Simply put, CMS undoubtedly recognized that there are too many transactions that are subject to the FMV requirement to insist that all valuations be conducted by an independent third party. That said, a frequent remedy in settlements and corporate integrity agreements has been to require the settling party to obtain outside valuations for a subset of its riskier transactions for an agreed-upon period of time.9

C. When Do-It-Yourself Appraisals Are Sufficient

While health law regulatory guidance clearly allows for DIY valuations, it is not entirely clear as to when DIY valuations are sufficient versus independent third-party appraisals. Certainly the fact that DIY appraisals are allowed at all suggests the government felt that in some circumstances, a DIY appraisal would be sufficient. The key passage from the commentary above suggests that the government’s concerns with DIY appraisals are mainly bias, manipulation, rigor and consistency of internal valuations versus independent ones.10

Thus, the parties’ decision of which transactions to value internally and which to value externally likely should be based on the risk of those factors (internal bias, rigor, etc.), as well as the relative risk of exposure to healthcare liability (i.e., some transactions are riskier than others simply because their characteristics alone may tend to suggest inducement, whether or not any inducement actually exists, including, for example, those with high dollar remuneration amounts or those with physicians who are large referral sources rather than merely occasional referral sources). Importantly, some transactions that may seem simple to value may actually be quite risky due solely to the fact that there are substantial referrals between the parties. Furthermore, because entities that receive referrals from physicians face substantially greater penalties and financial risk under the Stark law scheme (because they file the Medicare claims for the “designated health services or “DHS”), they are more apt to need the extra protection of an external appraisal than the physicians.11

D. Best Practices for Do-It-Yourself Valuations:

Assuming that a party has elected to conduct a DIY valuation, there is nothing akin to the local hardware store where one can simply buy the prefabricated parts and tools. However, there are some things an entity can do to help ensure that it gets the most protection possible from potential liability, despite the inherent risks of the DIY approach. Here are a few best practices:

  1. Use A Consistent Method
    Using the same approach in a regular and consistent manner to value recurring, similar transactions is one of the best ways to demonstrate to regulators and prosecutors that a valuation was free from bias and manipulation. However, as a practical matter, this can be difficult, when one considers that FMV is often diametrically opposed to the underlying missions and objectives of the parties. Most physicians and DHS entities exist primarily to provide healthcare services (and products) to their patients, customers, and communities, and in the case of for-profit entities, they all have the additional primary objective to turn profits for their shareholders. Pressure will often exist to stray from a consistent approach to meet key objectives, and having the right compliance process in place to avoid this temptation and remain consistent in the valuation approach is sometimes a formidable challenge.
  2. Use Multiple Valuation Approaches
    In general valuation theory, the use of multiple valuation approaches is preferred as it mitigates the drawbacks of each individual approach.12 The Stark law recognizes that it is not always possible or practical to use certain approaches,13 but consideration of multiple approaches is always a prudent practice, even if ultimately only one approach is carried out.
  3. Use Multiple Objective Surveys
    The government has indicated that use of “multiple, objective, independently published” physician salary surveys is a “prudent practice.”14 However, in many organizations, there is a tendency to gravitate toward one physician salary survey in particular, most commonly the Medical Group Management Association or “MGMA” survey. While MGMA is certainly considered by many to be the “gold standard” of physician salary surveys with the best and most extensive data and reporting, it does have certain drawbacks.14 Similar to using multiple valuation approaches, using multiple surveys mitigates the drawbacks of each individual survey.
  4. Avoid Cherry Picking Survey Data
    The surveys slice and dice the data in numerous ways, including regional and state data, size or type of practice. Parties should avoid the temptation to focus solely on data tables that support a particular result or position. Using a table only when it is shows the highest value, and avoiding it when is has lower values than other tables is dangerous. A consistent approach is the best practice, with recognition that sometimes the tables used will have values that are higher or lower than other tables, and sometimes they are unable to support a proposed transaction.
  5. Beware of Productivity Ratios in the Survey Data
    Certain surveys report “productivity ratios” or “conversion rates” such as compensation per work-relative-value-unit (“wRVU”) rates or compensation to collections ratios. These ratios are tempting to use in setting productivity-based compensation rates. While productivity-based compensation is popular and is generally a fair and reasonable structure, the conversion rates reported in the surveys can be highly misleading. It is important for users to know that the surveys calculate the rates from the compensation and productivity data, and that the relationship between productivity and compensation is not a linear correlation. That is to say, the surveys clearly warn that as productivity increases, compensation increases, but compensation per unit of productivity actually decreases.15 The behavior holds for all specialties over the last four years that data has been available. There are likely multiple causes of this phenomenon, but detailed examination is beyond the scope of this article. Still it is important for DIY valuations to recognize this fact when using productivity ratio data.
  6. Beware of Anecdotal Data and Strategic Value
    Parties will often wonder why FMV is not simply what the physician right down the street is getting paid, but even assuming that the anecdotal information is reliably reported (which often it is not), the use of anecdotal data is particularly dangerous. First, the parties down the street may have very different circumstances (e.g., terms, conditions, payor mix, etc.), making a true comparison challenging, at best. Further, anecdotal information typically represents a transaction between parties in a position to refer to one another, which is generally considered tainted data under the Stark FMV definition.16 There is no guarantee that the compensation rate down the street is consistent with FMV or was even analyzed at all. Just because a nearby doctor gets paid a particular rate in another deal does not necessarily make it FMV for the subject transaction.

    Similarly, FMV is a hypothetical standard that specifically excludes notions of “strategic value” or “investment value.” The parties will often want to consider the unique value they bring to the table (which can include the referrals, but also other synergies like, for example, proximity, shared knowledge of their particular market and situation, or shared vendor relationships). While those unique elements might otherwise have significant value to the parties, they cannot be considered in determining FMV for transactions subject to healthcare law, and thus, they cannot be included in the remuneration paid under healthcare transactions.
  7. Avoid Valuations Based on “Opportunity Cost” Calculations
    The government has indicated that compensation based on a theory of “lost opportunity” is potentially problematic.17 Doctors will often argue that certain activities, such as call coverage or medical directorships take up valuable time, which they otherwise could have used to perform procedures or patient care services. However, the government strongly disfavors payments that are based on mere speculation of what a doctor will do or could have done in the same time.19 Thus, it seems one would need evidence that either (i) those activities were actually displaced, or (ii) the doctor actually lost business. In practice, when a doctor agrees to perform a new task (e.g., a medical directorship), if he or she has had no material loss in patient volume or revenue as a result, a claim of “lost opportunity” will likely be met with skepticism. Frankly, because of the government suspicion of payments based on mere speculation of lost business, even a legitimate argument of lost business is apt to be subject to heavy government scrutiny.20
  8. Beware of Circular Databases – Databases Heavily Influenced by One’s Own Transactions are Dangerous
    Some services exist where FMV is determined by soliciting rates from subscribers to the service and then regurgitating that data back to the subscribers to help them determine FMV. While unrelated transactions may be in the database, the existence of user-provided transactions is dangerous, because it can lead to self-fulfilling results, which can cause rates to be determined in a circular fashion, with ever-escalating rates being labeled as FMV. FMV generally should not be based on what an entity has already agreed to with other parties.21 This can have dangerous consequences. While the major salary surveys are also at risk for this kind of effect, it is far less prevalent, given their larger sample size, and given the ability to mitigate the impact of any one survey by consideration of other surveys.
  9. Avoid Rewarding Internal Valuators Based on Deal Success or Related Profits (e.g., Ancillary Revenue)
    This concept may seem obvious at first glance, but in practice, it is often hard for internal personnel to avoid feeling pressure to get deals done (especially at for-profit entities). Thus, it is critical for DIY valuations to be free from any financial incentives that might suggest analysts were compensated based on the success of deals or any related profits, including, for example, ancillary revenue. When added to the concerns the government already has with DIY valuations versus outside analysis,22 even the mere perception of profit or deal-triggered financial incentives for valuators would clearly undermine the credibility of a DIY valuation.
  10. Consider Valuation Frameworks -- Have the Framework Reviewed by Independent Third Party
    Depending on an organization’s particular needs, it may be prudent to engage a third-party appraiser to evaluate an internal framework that is utilized consistently for analysis of multiple recurring arrangements. This is frequently seen with larger entities that have a lot of similar transactions, such as call coverage, medical directorships, and hospital-based subsidy arrangements. The third party is not assessing the reasonableness or accuracy of any specific facts or circumstances that are associated with an internal analysis. Rather, the third-party valuator will test the framework extensively, and provide an opinion which states, in essence, that while it is not analyzing any transaction directly, if the internal framework is used correctly, it is expected to yield results that are consistent with FMV. The relative cost is small to gain what likely is significant extra protection.

E. Conclusion

While DIY valuations are generally riskier than external assessments, they are a necessary fact of life at many healthcare entities. Nevertheless, there are a number of important steps parties can take to mitigate the relative risk of DIY appraisals, thereby reducing the potential healthcare law violation risk. Some of the recommended steps are admittedly easier than others to implement in practice, but all of them are worth considering, given the associated exposure.

1Among the laws and regulations that may have FMV requirements are: (i) the Physician Self-Referral Prohibition or “Stark” law (42 U.S.C. § 1395nn); (ii) the federal Anti-Kickback Statute (42 U.S.C. § 1320a-7b); (iii) Internal Revenue Service (“IRS”) Private Benefit Guidance and Intermediate Sanctions rules (see Treas. Reg. 53.4958 et seq.); (iv) the Foreign Corrupt Practices Act (15 U.S.C. § 78dd-1); and others.
2The IRS first defined its FMV standard in Revenue Ruling 59-60, and the Stark law modified it in 42 U.S.C. § 1395nn(h)(3) and 42 CFR § 411.351. To get a sense of how difficult FMV can be to determine in the context of the IRS and Stark definitions, consider the 947-page textbook on the subject entitled: “BVR/AHLA Guide to Healthcare Industry Compensation and Valuation,” edited by Timothy Smith and Mark O. Dietrich (2012).
342 CFR § 411.351 contains the definition. Commentary on the Stark definition is found at: 72 Fed. Reg. 51015 (September 5, 2007); 69 Fed. Reg. 16107 (March 26, 2004); 66 Fed. Reg. 944 (January 4, 2001); and 63 Fed. Reg. 1686 (January 9, 1998).
4The Stark commentary states, “[m]oreover, the definition of ‘fair market value’ in the statute and regulation is qualified in ways that do not necessarily comport with the usage of the term in standard valuation techniques and methodologies.” The commentary also indicates that commenters suggested that CMS create a rebuttable presumption similar to the IRS notion (See Treas. Reg. 53.4958 et seq., which includes provisions that create a rebuttable presumption that the parties did not intend to confer a private benefit, thereby reducing or eliminating liability, if they rely in good faith on a qualified independent valuation), but CMS declined to create a similar framework, stating instead, “[w]hile good faith reliance on a proper valuation may be relevant to a party’s intent, it does not establish the ultimate issue of the accuracy of the valuation figure itself.” 69 Fed. Reg. 16107 (March 26, 2004). Previously, the Office of Inspector General of the Department of Health and Human Services (“OIG”) had also explained the rationale for its differences from IRS guidance in 56 Fed. Reg. 35972 (July 29, 1991).
5See note 3.
666 Fed. Reg. 944 (January 4, 2001).
7See note 4.
866 Fed. Reg. 945 (January 4, 2001).
9See for example, Corporate Integrity Agreement between OIG and HCA, Inc. (2000), and Deferred Prosecution Agreements between the U.S. Dept. of Justice and Stryker, Zimmer and other device manufacturers (2007).
1066 Fed. Reg. 945 (January 4, 2001).
11The Stark law prohibits financial relationships between physicians and entities they refer patients to for “designated health services” (referred to as “DHS entities”), unless the financial relationship fits into a Stark exception (42 U.S.C. § 1395nn(a)(1)). Penalties for any DHS entity that violates Stark are based on the magnitude of DHS claims it files (42 U.S.C. § 1395nn(g)). DHS is a defined list of certain specific medical services (mostly imaging, lab and other “technical” component or ancillary services), which importantly include all inpatient and outpatient hospital services, and most orders for drugs or medical devices (42 U.S.C. § 1395nn(h)(6)). Thus, with those broad inclusions, nearly all transactions between physicians and hospitals, and most of those between physicians and pharmaceutical and device companies, are subject to the Stark law.
12Revenue Ruling 59-60 describes the three major approaches to value (commonly referred to as the “cost approach,” “income approach,” and “market approach”) and suggests that whenever possible, all should be considered when determining FMV. It is similar to the theory of diversifying one’s portfolio of investments, where the diversity of investments mitigates the unique risk of each individual investment, leaving the portfolio subject primarily to the overall market risk (see “Portfolio Selection,” The Journal of Finance, Markowitz, H.M. (March 1952)).
1369 Fed. Reg. 16107 (March 26, 2004).
1472 Fed. Reg. 51015 (September 5, 2007).
15The drawbacks of the MGMA survey include without limitation: (i) the fact that it does not represent a random sample (responses are voluntary and may indicate a bias); (ii) relative lack of localized data; (iii) admitted danger of misinterpreting productivity ratios (due to how they are calculated); and (iv) limited data on certain metrics, such as benefits or hours worked. Details regarding the survey are found at
16MGMA Physician Compensation and Production Survey, 2013 Report based on 2012 Data. MGMA has consistently warned about this issue in its survey for the last four years. Examination of MGMA data shows the phenomenon applies consistently to all specialties examined and over an extended time period (see BVR/AHLA Guide to Healthcare Industry Compensation and Valuation cited in note 2 above).
17The Stark regulatory commentary states that the valuation methodologies used “….must exclude valuations where the parties to the transactions are at arm’s length but in a position to refer to one another.” 69 Fed. Reg. 16107 (March 26, 2004).
18See for example, OIG Advisory Opinions 12-15, 09-05 and 07-10 where the OIG listed payments for call coverage based on lost opportunity as potentially problematic. See . The Stark regulatory commentary also stated that clinical rates and administrative rates may be different, suggesting disfavor for using clinical rates to value administrative services and vice versa. 72 Fed. Reg. 51016 (September 5, 2007).
19See note 16.
20Similar to the skepticism the government has regarding DIY valuations, its suspicion seems based on the risk of abuse and manipulation in speculating lost business. One example that might demonstrate why this suspicion exists is the case of U.S. ex rel. Singh v. Bradford Regional Medical Center, et al., 752 F. Supp. 2d 602 (W.D. Pa., 2010), where the physicians were paid in part for a non-competition agreement that required them to refrain from operating a wide variety of “potential” medical services, many of which they likely had no intention of ever operating anyway.
21The 4th Circuit Court of Appeals explained that “… as a legal matter, a negotiated agreement between interested parties does not ‘by definition’ reflect fair market value. To the contrary, the Stark Act is predicated on the recognition that, where one party is in a position to generate business for the other, negotiated agreements between such parties are often designed to disguise the payment of non-fair market value compensation.” (U.S. ex rel. Kosenske vs. Carlisle HMA, Inc., 554 F.3d 88, 4 th Cir., January 21, 2009).
2266 Fed. Reg. 945 (January 4, 2001).


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