PHYSICIAN-HOSPITAL RECRUITING: OVERVIEW OF REGULATORY REQUIREMENTS. Charlene L. McGinty Marc D. Goldstone Hal McCard

PHYSICIAN-HOSPITAL RECRUITING: OVERVIEW OF REGULATORY REQUIREMENTS Charlene L. McGinty Marc D. Goldstone Hal McCard Physician recruitment activities have been the subject of intense scrutiny by federal enforcers for years. Scrutiny has been on the basis of federal tax, self-referral, and fraud and abuse laws. Below is an overview of the issues and requirements under each of these laws. Federal Tax Tax-Exempt Considerations Under federal tax law, a tax-exempt entity, cannot be operated in such a manner that an insider or private person may benefit from its activities. With respect to physician recruitment arrangements, the following considerations are set forth in guidance from the Internal Revenue Service ( IRS ) in Revenue Ruling 97-21, 1997-1 C.B. 121 (4/21/97): There must be a demonstrable community need for a physician (as distinguished from a hospitalor physician clinic need for physician services); All incentives offered or provided to the physician must be reasonable; The recruiting agreement must be in writing; and The hospital s governing body must become involved in, and assume responsibility for, the hospital s recruitment activities. Revenue Ruling 97-21 discusses four physician recruitment situations that did not jeopardize the hospital s continued tax-exempt status under section 501(c)(3) of the Internal Revenue Code of 1986, as amended ( IRC ). Those situations are as follows: Situation 1: Hospital A is located in a rural area and is the only hospital within a 100- mile radius and is considering recruiting an ob/gyn who has recently completed residency and is not on the Hospital s medical staff. The U.S. Public Health Service has designated the county in which the Hospital is located as a Health Professional Shortage Area ( HPSA ) for primary care professionals (which includes obstetricians and gynecologists). The Hospital provides the following incentives: (1) a signing bonus, (2) pays the physician s professional liability insurance premium for a limited period, (3) provides an office at initial rates below market for a limited period after which rates will be at fair market value, (4) guarantees physician s mortgage on his residence in the hospital s county and (5) practice start-up financial assistance. The IRS found that Hospital A has objective evidence demonstrating a need for obstetricians and gynecologists in its service area and the provision of incentives under the circumstances described furthers the charitable purposes served by the hospital Situation 2; Hospital B is located in an economically depressed inner-city area and is recruiting a pediatrician who currently practices outside hospital s service area and who is not on

the hospital s medical staff. The Hospital conducted a community needs assessments that indicated both a shortage of pediatricians and difficulties of Medicaid patients in obtaining pediatric services. The Hospital provides the following incentives: (1) reimbursement for moving expenses, (2) reimbursement for physician s professional liability tail coverage, and (3) a net income guarantee for a limited number of years. Again, the IRS found that Hospital B has objective evidence demonstrating a need for pediatricians in its service area... and the provision of incentives under the circumstances described furthers the charitable purposes served by the hospital Situation 3: Hospital C is located in an economically depressed inner city area and is recruiting an obstetrician currently on its medical staff to provide obstetric services to Medicaid patients. The Hospital s community needs assessment reflected that indigent patients were having difficulties getting access to care for these services due to the shortage of obstetricians in the service area who were willing to treat Medicaid and indigent patient. The Hospital provides the following incentive: reimbursement of the cost of one year s professional liability insurance. The IRS states that the Hospital C has identified a shortage of obstetricians willing to treat Medicaid patients and that the recruitment activity described is consistent with the requirements for exemption Situation 4: Hospital D is located in a medium to large size metropolitan area and is recruiting a diagnostic radiologist who provides services to patients at another hospital located in the same metropolitan area. The Hospital requires a minimum of four diagnostic radiologists to ensure adequate coverage and high quality of care for its radiology department, but two of the four are relocating outside the Hospital s service area. The Hospital provides the following incentive: a net income guarantee for the first few years of practice. The IRS states that Hospital D has objective evidence demonstrating a need for diagnostic radiologists to provide coverage for its radiology department and that the recruitment activity described is consistent with the requirements for exemption One significant fact the IRS considered in this situation is that the Hospital s Board of Directors determined that it needed additional diagnostic radiologists to provide adequate coverage and to ensure a high quality of medical care to the community. Note that the IRS discussed one further situation where it found that the Hospital s recruiting activities were not consistent with the requirements for exemption. In that situation, the Hospital had been found guilty of violating the fraud and abuse laws with respect to its physician recruiting activities. Accordingly, the IRS found that the Hospital did not comply with section 501(c)(3) requirements. For additional guidance from the IRS on physician recruitment (some of which has now been superseded by Revenue Ruling 97-21), see Gen. Couns. Mem. 39862 (Nov. 21, 1991) - this GCM dealt with the community benefit requirement. The IRS defined community benefit in terms of improvement in access, cost or quality of health care services. Community need is a subset of community benefit, and deals with expanding access to health care services in the community. This does not mean that a hospital specific need is equivalent to a community need. 2

Hospital Audit Guidelines(Announcement 92-83, 1992-22 I.R.B. 22, 333). This Manual, used by IRS examining agents, encourages the agents to look at all aspects of the recruiting arrangement, but to look closely at arrangements where there is no repayment obligations. The agent are instructed to look for an identifiable community need or benefit. Hermann Hospital Physician Recruitment Guidelines, released on October 19, 1994, which has been superseded by Revenue Ruling 97-21 Intermediate Sanctions To the extent that a recruited physician serves in a capacity that might otherwise be considered a person with substantial influence over the hospital s activities, or is being recruiting into a group that fits this description, a tax-exempt entity will also need to ensure that the arrangement meets the requirements for a rebuttable presumption of reasonableness under the IRS Intermediate Sanctions rules (IRC section 4958). To satisfy these requirements, the arrangement must: Be approved by the governing body or a committee of the governing body composed entirely of individuals who do not have a conflict of interest. An individual does not have a conflict of interest if that person: o is not, and is not related to, the disqualified person who benefits from the transaction; o is not an employee who is subject to the disqualified person s control; o has no material financial interest affected by the transaction; and o will not receive economic benefit from another transaction to be approved by the disqualified person. The governing body or committee must obtain and rely upon adequate comparability data before approving the agreement. Adequate comparability data might include: o Compensation paid by similar organizations for comparable positions; o Availability of similar services in the geographic area; o Independent compensation surveys compiled by independent firms; o Actualwritten offers from similar organizations. The governing body or committee must document the basis for its approval when the decision is made, including: o Terms of the agreement and date approved; o Members present during discussion and how they voted; o Comparability data relied upon and how it was obtained; o Any actions taken with respect to consideration of the agreement by anyone with a conflict of interest. If the governing body does not use comparability data, then the basis for the determination of compensation must be documented. Income Tax Considerations Consideration must also be given to the tax consequences to the Hospital, to the physician or physician group, as applicable, for the payments made under the recruiting agreement and the 3

repayment obligations. This will also impact the timing of the issuance of the Form 1099 and when the physician/physician group must treat the payment as income. Under current advice issued by the IRS, payments to a physician under a recruitment agreement must either satisfy certain requirements common for a standard commercial loan e.g., require repayment at a time certain, applying interests rates and requiring specified payment amounts or must be treated as income to the physician at the time the payment is made to the physician. For additional IRS guidance on the tax treatment, see Beaver v. Commissioner, 55 TC 85 (1970), Nix v. Commissioner, TC Memo 1982-330 (1982), Katsaros v. Commissioner, TC Memo 1999-23 (1999), PLR 200040004. The Hospital s auditors will likely advise the Hospital to issue the Form 1099 as and when the payments are repaid by service, rather than at the time the payment is made. Anti-Kickback Statute The Practitioner Recruitment safe harbor to the Federal Anti-Kickback Statute was published November 19, 1999 ( 64 Fed. Reg. 63518) and is now codified at 42 C.F.R. 1001.952(n). This safe harbor has limited applicability in that it requires that the recruiting entity be located in a HPSA. Typically, HPSAs recognize only three types of specialties -- primary care, mental health and dentistry. However, primary care physicians include the areas of general and family practice, general internal medicine, pediatrics and obstetrics and gynecology. To determine if a particular area is designated as a HPSA for each specialty, go to www.bhpc/hrsa/gov/dsd. The safe harbor criteria are as follows: Written document, signed by the parties, that specifies the benefits provided by the recruiting entity, the terms under which the benefits are provided, and the obligations of each party; If a practitioner is leaving an established practice, at least 75% of the new practice revenues must be generated from new patients; Benefits are paid for no more than 3 years, and may not be renegotiated during that period; There is no requirement that the practitioner refer to the recruiting entity, though the entity may require that the practitioner maintain staff privileges; The practitioner is not restricted from establishing staff privileges at or referring services to any other entity; The amount or value of the benefits provided do not vary based on the volume or value of referrals or other business generated for the recruiting entity; The practitioner agrees to treat Medicare and Medicaid patients; At least 75% of the revenues of the new practice are generated from patients residing in a HPSA or MUA (medically underserved area), or who are part of a medically underserved population; and The payment may not directly or indirectly benefit any person or entity in a position to make or influence referrals. The Office of the Inspector General ( OIG ) has provided further guidance regarding recruitment arrangements in an Advisory Opinion issued in 2001. According to the facts of the 4

OIG Advisory Opinion No. 01-4 (5/3/01), the hospital (i) was not located in a HPSA, but was in a MUA, (ii) gave incentives that included annual loans to the physician during residency with such amounts being forgiven over a 3-year period commencing with the establishment of physician s practice in the hospital s community. Although the situation did not fit four square in the above safe harbor, this Advisory Opinion indicates that the OIG will consider the following factors when evaluating a recruitment arrangement that does not qualify for safe harbor protection. Those factors are as follows: Whether there is documented evidence of an objective need for the services; Whether the practitioner has an existing stream of referrals within the recruiting entity s service area; Whether the benefit is narrowly tailored so that it does not exceed that which is reasonably necessary to recruit a practitioner; and Whether the remuneration directly or indirectly benefits other referral sources. According to the Advisory Opinion, an arrangement that minimizes the potential for abuse under these factors is unlikely to result in adverse action by the OIG. Another source of guidance from the OIG is the OIG Supplemental Compliance Program Guidance for Hospitals, 70 Fed. Reg 4854 (Jan. 31, 2005) (the CPG ) and the OIG Special Fraud Alert, Hospital Incentives to Physicians (May 1992) available at http://oig.hhs.gov/fraud/docs/alertsandbulletins/121994.html (the Special Fraud Alert ). Under the CPG, the OIG commented that it will look at the following factors (which are similar to the factors reviewed in Advisory Opinion 01-04): Does the benefit exceed that which is reasonably necessary to attract the recruit What is the duration of the payout of the recruitment benefit (risk of heightened scrutiny if this period exceeds 3 years) Is the physician relocating or new to the community What is the need for the recruitment - documented need The Special Fraud Alert addressed some common recruitment incentives and found potentially problematic incentives to include: The use of free or significantly discounted billing, nursing, or other staff services, office space or equipment Free training of a physician s office staff in areas such as management techniques, CPT coding and laboratory techniques Private practice guarantees Low interest/interest-free loans or loans that can be forgiven if the physician refers patients to the hospital Paying for a physician s continuing medical education Coverage of a hospital s group insurance plans at inappropriately low costs Paying for services in excess of fair market value of the services. 5

Stark II Stark II, Phase II created the physician recruitment exception which became effective July 26, 2004 (now codified at 42 C.F.R. 411.357(e); 69 Fed. Reg. 16054 (March 26, 2004)). Under this exception, remuneration paid by a hospital to recruit a physician that is paid directly to the physician and is intended to induce the physician to relocate his or her medical practice to the geographic area served by the hospital in order to become a member of the hospital s medical staff is permissible in all of the following requirements are met: The arrangement and its terms are in writing and signed by both parties; The physician is not required to refer patients to the hospital; The amount of remuneration under the arrangement is not determined in a manner that takes into account the volume or value of any actual or anticipated referrals; and The physician is not restricted from having medical staff privileges at other facilities. The hospital s geographic area is defined in the exception as the lowest number of contiguous postal zip codes from which the hospital draws 75% of its inpatients. This can be calculated using admissions or discharges, but the methodology used must be consistent regardless of the specialty of the recruit. For purposes of the exception, a physician is deemed to have relocated is he or she moves her practice at least 25 miles or 75% of the revenues in the new practice are derived from new patients not seen by the physician at his or her prior medical practice during the preceding 3 years. Note that residents and physicians who have been in practice for less than 1 year do not need to meet the relocation requirement, but these individuals will have to relocate to the hospital s geographic area. If the recruited physician will join a group practice, additional requirements are applicable. These are: The written agreement must be signed by the party to whom payments are directly made; The remuneration must be directly paid to the recruited physician except for actual costs incurred by the physician or practice in recruiting; The remuneration may not be related to the volume or value of referrals of the physician or group; The costs allocated under an income guarantee may not exceed the actual additional incremental costs attributed to the physician; The arrangement does not violate the Anti-Kickback Statute or any federal or sate law regarding claims submission; The group may not impose additional practice restrictions, other than those that relate to quality of care; and The group must maintain records of actual costs and pass-through amounts for five years and make those records available to the Secretary of the Department of Health and Human Services upon request. 6

If the recruiting arrangement is with an existing group practice, no payment under the recruitment agreement may inure to the benefit of the group practice. To ensure that this criterion is satisfied, the following may be considered: That all payments under the agreement be made directly to the recruited physician, and not to the group; That the fair market value of the payments be determined by an independent third party appraisal; That the group be made a party to the agreement to acknowledge that: No payments to the physician under the agreement will be used for any purpose other than the incremental costs of adding the recruited physician to the practice and the hospital has the right to get data from the group to confirm this; To the extent the practice has entered into a separate agreement with the recruited physician (the Group Agreement ) that includes a noncompete provision, such noncompete provision is null, void, and of no effect until the hospital has recovered its investment; The group will timely credential the physician and bill for his/her services (this is particularly important where the recruitment package offers an income guarantee); The group will compensate the physician in an amount not less than the amount payable under the recruitment package; The hospital will hold a security interest in the recruited physician s receivables as security for the repayment obligations under the recruitment note; That combined compensation for the recruited physician, including any and all amounts paid under the recruitment agreement and any and all amounts paid under the Group Agreement, will not exceed fair market value for services rendered; and That the recruited physician agrees to report to the hospital any increase in base compensation under the Group Agreement to an amount that exceeds fair market value as established in the recruitment agreement, and agrees that the hospital has the right to decrease the amounts payable under the recruitment agreement as it deems appropriate, in its sole discretion, to ensure that payments to physician do not exceed fair market value. The Centers for Medicare and Medicaid Services ( CMS ) has now given further guidance on physician recruitment, and this time not through the rule-making process. CMS issued an advisory opinion in November 2006 (CMS-AO-06-01). In this Advisory Opinion, CMS tackled the issue of when a physician has relocated his or her practice. The factual background in this recruitment arrangement is as follows. The Hospital and a primary care practice (the Practice ) 7

were proposing to jointly recruit a primary care physician to relocate to the area. The Practice had three practice locations, two of which were in the Hospital s geographic area. The Hospital and the Practice entered into an agreement with a search firm to conduct the search for the recruit, with each agreeing to pay one-half of the search firm s fees. Under the recruiting arrangement with the physician, the Hospital would make the following loans directly to the physician: (1) a loan for payment of the physician s moving expenses (forgivable after one year); (2) a loan equal to physician s first year medical malpractice premium not to exceed $10,000 (forgivable over three years); and (3) a loan to repay physician s medical school loans (forgivable over three years). Under the arrangement, the physician would spend 80-90% of his or her time practicing in the Hospital s geographic area and 10-20% of his or her time practicing outside the Hospital s geographic area. After review of the arrangement, CMS stated that there is no explicit requirement in the physician recruitment exception that the recruited Physician spend 100 percent of his or her medical practice time in the geographic area served by the Hospital. However, CMS stated that the result may be different if the recruit spent more time outside the geographic area than as set forth in the facts of the Advisory Opinion. Practical Considerations The key factors in ensuring that a physician recruitment strategy is ultimately successful is to set expectations so that all parties are on the same page and to have a clearly defined exit strategy. Some of the key considerations in setting expectations is: Don t let the medical group do the first interview alone; so that there are no unanticipated outcomes, make sure the hospital is involved in the process. Never say never, or always, or no cost to you, unless you are sure that s the case -- this is all the physician or the group will remember. Make sure all parties know the applicable federal and state regulatory rules and requirements for physician recruiting. Always confirm community need. Never assume that the community need is static and will be met because there was a previous need. Demand transparency. If the physician or the group is going to take the hospital s money, there must be transparency and no hidden agenda (or hidden compensation. Make sure everyone signs the same 3-party agreement. Maker sure each party has an attorney who is well-versed in the regulatory rules and requirements for physician recruiting. Who is doing the background checks, and when? 8

Has the hospital received an executed Security Agreement with the Form UCC to file in the appropriate venue in order to perfect the hospital s security interest in the assets securing the promissory note? Make sure the new physician is eligible for privileges at the hospital and that the group takes all steps to expedite this process. Likewise, make sure the group or physician expedites the process of being credentialed by third party payor plans. If an income guarantee is being given, have all parties agreed on what is covered in the additional incremental expense category? Last tip - always plan for worse case scenario. Have an exit strategy and negotiate and document the various strategies in advance. 9