The Health Care Investor : Healthcare Lawyers & Attorneys for Life Science Companies & Investors

This blog post is the second in a series examining the potential impact of health reform on medical device companies.  The first post can be accessed here. 

1.                  Payment Reductions. The Healthcare Reform Act did not include direct payment reductions that apply to specific types of medical devices, however there are provider payment reductions that will indirectly affect medical device manufacturers. For example, total payment reductions to hospitals during 2011 are expected to be in the range of.35% less than 2010 payments, according to the American Hospital Association.The Congressional Budget Office estimates that this will amount to $112.9 billion in hospital payment reductions over the next ten years. These reimbursement reductions will directly affect hospital budgets for certain types of capital spending and for spending related to devices that are not reimbursed as part of a Diagnostic Related Group. Device manufacturers should understand their customers’ budgets so they can anticipate whether their hospital and other provider customers may decrease their budget allocations for device purchases.

2.                  Stricter Fraud and Abuse Scrutiny. The Healthcare Reform Act amends certain federal fraud and abuse laws. Specifically, the Act amended the False Claims Act (“FCA”), the Anti-Kickback Statute (“AKS”) and the Federal Sentencing Guidelines. The FCA subjects a person to monetary penalties and/or imprisonment for knowingly and willfully falsifying, concealing or covering up a material fact, making materially false representations, or using a document known to contain any materially false statement. More significant to medical device manufacturers is the elimination of the FCA’s “Public Disclosure Bar.” The Public Disclosure Bar prevented a qui tam plaintiff from using publically available information as the basis for a claim against an entity suspected of violating the FCA. The removal of this bar will increase the potential financial reward for certain qui tam plaintiffs. Therefore, the number of claims brought against medical device manufactures will likely increase significantly. 

3.                  Shared Cost-Savings Reimbursement Programs. The Healthcare Reform Act sets forth certain reimbursement programs focused on rewarding providers for reducing the cost of care, including the formation of so called accountable care organizations, or “ACOs,” and extends an existing gainsharing demonstration program. An ACO is essentially an organization of physicians and other healthcare providers that is assigned a population of Medicare beneficiaries and is paid a share of savings achieved through coordinated care efforts, provided certain quality standards are achieved. Additionally, the Act authorized extension of the gainsharing demonstration program. While ACOs and gainsharing programs are not expected to have an immediate impact on medical device manufacturers, if these types of organizations gain traction, the utilization of certain devices and procedures may decrease. Device manufacturers that are preparing future sales projections should be aware of the development of these organizations and the potential impact thereof. 

4.                  Medical Device Innovation Funding.  The Healthcare Reform Act included funding for grant monies to spur medical device innovation. The grant program, called the Cures Acceleration Network, enables the Director of the National Institutes of Health to award grants in order to promote innovation in technology supporting advanced research, development and production of so called “high need cures,” including through the development of medical products. To receive grant money, an entity must submit an application containing detailed information about the project for which the entity is seeking the grant, contribute non-federal funds to the project in the amount of $1 for every $3 awarded under the grant, and must also issue a final report at the end of the project describing the project outcomes. The award maximum is $15 million per project for the first fiscal year that the project is funded, with the possibility of receiving additional monies of up to $15 million in the subsequent fiscal year. Currently, Congress has authorized $500 million for the program for fiscal year 2010. In addition to the grant program, the Healthcare Reform Act authorized the Qualifying Therapeutic Discovery Project, which grants a tax credit for any taxable year in an amount equal to 50% of the investment in any qualifying project. 

5.                  Pay for Quality. The Healthcare Reform Act includes numerous new initiatives pursuant to which provider reimbursement will be increased or decreased depending on the quality of care that providers are able to demonstrate. For example, Section 3008 of the Act provides that hospitals in the top quartile with respect to national rates of hospital acquired conditions will have their Medicare payments for all discharges reduced by 1%. Similarly, Section 3007 of the Act directs the Secretary to develop and implement a system where physicians are paid additional amounts for providing quality health outcomes for Medicare beneficiaries at a lower cost. These changes to payment systems will occur over an extended time period, but demonstrate that the CMS is moving toward a system focused less on payment for individual services, and more on paying for efficient, high quality, low cost care. Even more so than in the past, to successfully market devices, manufacturers will be required to demonstrate that hospitals and healthcare providers can improve efficiency, quality and value through the use of their medical devices. 

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As investors consider potential investments, it is important to take into account the future impact of the recently passed health reform legislation. This blog post is part I of an itemization of 10 areas of the health reform bill that will likely have an impact on companies that manufacture medical devices and supplies. Some of these effects may be positive and some may be negative – but any investor in a device company should be aware of these areas of the health reform legislation. 

1.                  Expanded Coverage. The primary purpose of the Healthcare Reform Act was to expand coverage to a broader range of patients in the United States. In part, the Act accomplishes this expansion through a significant broadening of the eligibility criteria for enrollment in Medicaid.  Specifically, the Medicaid expansion enables most individuals with incomes of less than 133% of the Federal Poverty Level to enroll in the Medicaid program. Additionally, the mandatory insurance requirement and broader availability of health insurance through Health Benefit Exchanges will help to ensure that there are more patients that have access to health care. Increases in access to care may result in a positive near-term impact on some device manufacturers, as a result of the increased demand for medical services. 

2.                  Future Cuts? The Act does not contain significant changes to reimbursement methodologies or major decreases in reimbursement for healthcare providers. Therefore, Congress will likely be back at the table within the next three to ten years to address the cost issues that are attendant with the expansion of availability of healthcare services. It is unclear how Congress will address these cost issues, but one possibility is that it will decrease reimbursement in the future. Device manufacturers that are in high-tech, high-cost niches should begin to plan for potential reimbursement reductions in their sector. Additionally, it will be important for all device manufacturers to be able to differentiate their products as providing true clinical benefits instead of simply building a “better mousetrap.” 

3.                  Medical Device “Tax”. The Act included new “industry fees” or taxes that are applicable to pharmaceutical and medical device manufacturers, insurance companies, and pharmacy benefit managers. The medical device fee is effective 2012, and manufacturers of a medical devices will be required to pay 2.3% of the sales price for such device as an industry fee. The definition of a “taxable medical device” includes any device that is defined in Section 201(h) of the Federal Food, Drug and Cosmetic Act and is intended for human use. A limited number of medical devices, including eyeglasses, contact lenses, hearing aids and any other device that is determined by Centers for Medicare and Medicaid Services (“CMS”) to meet the “retail exception,” are exempted from this fee. Unlike the pharmaceutical fee, the medical device fee applies to all manufactures, regardless of size and revenue levels.

4.                  Comparative Effectiveness. The Act laid the groundwork for future inclusion of comparative effectiveness measures when CMS makes payment decisions by funding a new independent entity called the Patient Centered Outcomes Research Institute (“PCORI”). The PCORI will study the effectiveness of various services, products and therapies and will issue reports regarding their effectiveness. The reports that are generated by PCORI may be relied on by CMS or other third party payors making decisions about payment, coverage and treatment. 

5.         Physician Payment Sunshine Act. The Healthcare Reform Act included the Physician Payment Sunshine Act. This will require covered manufacturers that make a payment or other transfer of value to a physician or teaching hospital to report such payments annually in electronic form. Payments or transfers of value include consulting fees, payments for clinical trial participation, charitable donations, royalties and a variety of payments that may be made to physicians and teaching hospitals. There are some payments that are exempted from the disclosure obligations. These exempted payments include annual aggregate payments to a recipient of less than one-hundred dollars and individual payments of less than ten dollars, payments that are made entirely through market research organizations, and the provision of samples to a physician or teaching hospital for the benefit of patients. 

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On May 26th, CMS released a proposed rule setting out new credentialing and privileging processes for physicians and other healthcare professionals who provide telemedicine services, a move which may lesson burdens on healthcare providers considering telemedicine options. Further, next week CMS is expected to release an additional proposed rule re additional services which may be reimbursed by Medicare if provided via telemedicine. Both rules, if they become law, could increase opportunities for growth in telemedicine companies.

Proposed Rule re Cross-Credentialing

Prior to January 1, 1999, Medicare coverage for services delivered via a telecommunications system was limited to services that did not require a face-to-face encounter under the traditional model of medical care, such as interpretation of an x-ray or electrocardiogram or electroencephalogram tracing, and cardiac pacemaker analysis. Then on October 1, 2001, section 223 of the Medicare, Medicaid and SCHIP Benefits Improvement Protection Act of 2000 significantly expanded Medicare telemedicine services services to include consultations, office visits, office psychiatry services, and certain other services that have been added over the years. However, in addition to state licensure and other issues faced by hospitals and physicians providing these services, one challenge for hospitals has been the process of granting credentials to these physicians. Under existing Medicare Conditions of Participation (CoP), the governing body of a hospital must make all privileging decisions based upon the recommendations of its staff, after the staff has examined and verified the credentials of practitioners applying for privileges. Thus a hospital must conduct individual appraisals of its prospective members and examine the credentials of each candidate to make a privileging recommendation to the governing body. Hospitals may use third-party credentialing verification organizations, but the governing body remains responsible for the privileging decisions.

By contrast, the proposed rule released on May 26th would allow the governing body of a hospital whose patients receive telemedicine services to grant privileges based on recommendations from its medical staff, which, in turn, would rely on information provided by the distant-site hospital. In the proposed rule, CMS would require the local hospital to verify that:

1. The distant-site hospital is a Medicare-participating hospital.

2. The physician is privileged at his own hospital and that the distant-site hospital provides the local hospital a current list of the physician’s privileges.

3. The physician holds a license issued or recognized by the state in which the local hospital is located.

4. The local hospital has evidence that the distant-site hospital conducts an internal review of the physician’s performance of his privileges.

The local hospital must provide relevant information to the distant-site hospital for its use in periodically evaluating the physician, including all adverse events that might have resulted from telemedicine services provided by the physician to the local hospital’s patients, as well as all complaints the local hospital has received about the physician. CMS believes its proposal would "allow for the advancement of telemedicine nationwide while still protecting the health and safety of patients." CMS is currently taking comments on the proposed rule through July 26th.

Anticipated Proposed Rule re Additional Telemedicine Services

According to the American Telemedicine Association, on or about July 13th CMS is expected to release an additional proposed rule re additional services which may be reimbursed by Medicare if provided via telemedicine. At a minimum, these two proposed rules suggest a greater degree of acceptance of telemedicine services than ever before. If the proposed rules becomes law, many hospitals will likely take advantage of such cross-credentialing options and opportunities to bill Medicare for additional telemedicine services, and telemedicine providers may flourish in the process.

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One aspect of investing in a healthcare facilities business of which investors should be aware is the impact of state certificate of need (CON) laws. A  CON is a state regulatory review process that requires an application to the appropriate state board for the grant of a CON prior to developing, or in some states expanding or modifying, a covered healthcare facility. CON laws arose in the 1960’s as many states attempted to curb rising healthcare expenditures through planning and regulation.  In 1974, Congress passed the National Health Planning and Resources Development Act, mandating that all states adopt CON laws.  A decade later, Congress allowed the federal law to expire, and several states quickly repealed or let sunset their CON laws. Now, according to the National Conference of State Legislatures, 36 states plus the District of Columbia have CON laws that govern some healthcare facilities. Some state laws govern primarily hospitals while other state laws govern a broader array of facilities. Supporters of CON programs believe they help ensure access to healthcare, keep quality high and lower costs by evaluating whether a particular service or facility is actually needed in the proposed area.  Opponents believe it stymies healthy competition that is needed to keep quality high.

Investors should become familiar with the CON requirements, if any, in the states in which their target businesses operate, including the facilities governed by the CON laws and the rules on expansion and modification. Investors should consider whether such restrictions work to the businesses’ benefit currently and whether the restrictions will continue to be beneficial in the future. The presence or lack of state CON requirements also will likely factor into valuation of the business. In certain circumstances, a CON can be considered a valuable asset of the business that was hard-fought and costly to obtain, and state CON requirements can in some cases function as a protection for the business against emerging competitors in at least the short term. However, in most states, CONs are tied very specifically to a designated location and designated size (e.g. based on number of beds, procedure rooms etc) and facilities in a CON state can have less flexibility in terms of modifying business lines as facilities in non-CON states. In those CON states closely regulating expansion and modification, obtaining the necessary approvals can be an expensive and lengthy process.

Additionally, investors should understand the workings of the state CON board and the current political and legal issues facing those boards. For example, the gle provides that no person shall construct, modify or establish certain types of healthcare facilities or acquire major medical equipment without first obtaining a CON or exemption from the Health Facilities and Services Review Board (the Board).  In a recent article, McGuireWoods healthcare attorneys Jeff Clark, Jason Greis and Joe Hylak-Reinholtz discussed some key recent changes to the Illinois CON law impacting Illinois healthcare providers and their investors.  The authors discussed that on March 1, 2010, an important provision in the Illinois law relating to the legislature's decision to alter, yet again, the number of members on the Board (increasing its size from five to nine members) became effective. The change represents the third time since 2003 that the state legislature has altered the number of members on the Board. The change is important because the addition of four Board members could create new opportunities or lead to unforeseen challenges for future CON applicants. The viability of potential projects may be shaped by the individuals Governor Quinn appoints to fill the new Board vacancies. Changes such as these in state CON laws and boards can have significant impacts on a business and should be carefully considered by investors as well.

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In prior posts I’ve discussed the significant impact of the Patient Protection and Affordable Care Act (the PPACA, more commonly referred to as the healthcare reform legislation) on the physician-owned hospital industry.  Section 6001 of the PPACA stymies growth of the industry by prohibiting expansion of existing physician-owned hospitals and bans any new physician-owned hospitals that are not Medicare-certified by December 31, 2010 (i.e. hospitals violating those limitations will not be permitted to bill Medicare/Medicaid for referrals made by their physician owners). Although a number of exceptions apply to the expansion prohibition, most industry analysts believe meeting the exceptions will be challenging to virtually impossible for existing physician-owned hospitals.

According to a press release issued today by Physician Hospitals of America (PHA), the trade association for the industry, there are approximately 265 existing physician-owned hospitals, 29 of which are scheduled to open and receive their Medicare certification by December 31, 2010. An additional 45 hospitals are currently under development and are not expected to be open or Medicare-certified by December 31, 2010. According to PHA, there were also 39 hospitals that were previously under development but were abandoned as projects due to passage of Section 6001.

In response to Section 6001, PHA and Texas Spine & Joint Hospital (TSJH) jointly filed suit today in U.S. Federal Court, Eastern District of Texas, challenging the constitutionality of Section 6001 on grounds that the law is a violation of due process and equal protection rights, and that the Section is void due to a contradictory, vague and arbitrary nature. TSJH is a privately owned hospital specializing in orthopedic and spine surgery, procedures, and tests which had sought and won local zoning approval to expand its facility with an additional 20 Medicare beds, which expansion project would now be prohibited by Section 6001.

Industry supporters and opponents will be carefully following progression of the lawsuit as the resolution is anticipated to have a profound impact on the ability of the physician-owned industry to thrive.

Scott Oostdyk and Victor Moldovan of McGuireWoods are representing PHA and TSJH in the lawsuit. 

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We recently had the opportunity to travel with Amsino International to visit several of Amsino’s medical device manufacturing facilities located in and around Shanghai, China. The experience prompted two key observations regarding the global health care system and its impact on medical device manufacturers. Investors in medical device companies would be well served to factor these two key issues into plans and projections.   

1.                  The “China Price” is Not Just Labor Cost Driven. Many commentators have spoken about the importance of the “China Price” in driving lower cost of medical devices, pharmaceuticals and medical supplies. At the same time, there has been concern expressed about whether the “China Price” will remain low if labor costs increase significantly in China. This has particularly been a concern as recent protests at auto manufacturing plants and other activities have shown that the Chinese government and Chinese workers may push for higher compensation, and benefits for Chinese workers. However, in talking to medical device manufacturers in China, it is clear that the “China Price” is not just driven by low-cost labor. Instead, many manufacturing districts in China have organized in such a fashion that they are able to deliver extremely low-cost and high-quality medical products due to the mix of resources that is available in these manufacturing districts. 

The resources include the availability of supplies and suppliers, the availability of low-cost machines and tooling, access to transportation, expertise in manufacturing, quality control, and other necessary inputs. Shanghai in particular has organized itself around manufacturing and delivery of low-cost, high-quality goods with its convenient port access to the Yangtze River and the Pacific Ocean. It is clear that although labor costs may rise in China, the other factors that elevated China into a manufacturing hub will not soon change. Therefore, even if labor costs go up, there will still be significant value that Chinese manufacturers can deliver. 

2.                  The Growing Middle Class and China’s Version of Health Care Reform Will Significantly Expand the Market for Medical Devices, Supplies, and Pharmaceuticals in China. The second observation that one immediately comes to in traveling around Shanghai is the amazing growth of the Chinese middle class. This increasingly fairly compensated group is demanding more from their government class in the form of health care and other essential services. It is this growing middle that has pushed the government in part to announce last year an ambitious health care reform plan that will “fix the ailing medical system” and “insure fair and affordable health services for 1.3 billion citizens”.

Over the past year the Central Committee of the Communist Party of China and the State Council have expanded on what China’s version of health care reform will encompass. Most importantly, it will include the spending of approximately 850 billion Yuan ($124 billion US dollars) over the next three years. One of the cornerstones of this reform is the construction of an astounding number of new hospitals and health care facilities throughout rural China. Each of these new hospitals will require initial equipment purchases, as well as a new source of medical supplies and pharmaceuticals. These health care reform activities will clearly drive increased utilization in China.

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Now more than ever, it is critical that anyone contemplating investment in a healthcare sector carefully review the target company’s compliance protocols. We have always strongly recommended that investors analyze the company’s compliance program, as well as efforts at adhering to the program requirements, in order to better gauge the company’s overall goals and philosophy regarding compliance. Understanding a company’s compliance culture can help the buyer assess the risks it may be taking with investment in the company and what challenges, if any, may be on the horizon for the company.

Now, under the Patient Protection and Affordable Care Act (the PPACA, more commonly referred to as the healthcare reform legislation), certain healthcare providers, as a condition to participation in Medicare, must have in place a compliance plan that meets the requirements to be laid out by the Secretary of HHS. The PPACA lists several detailed requirements for the compliance plans of skilled nursing facilities (SNFs), likely due to the industry’s historical scrutiny and highly publicized investigations from the SNF industry in the past few years. SNFs must implement these compliance plans pursuant to the requirements of Section 6102 of the PPACA within 36 months following passage of the PPACA, and regulations must be issued by the Secretary of HHS for SNFs with additional guidelines no later than two years following passage of the PPACA. 

By contrast, the Secretary of HHS is mandated with determining which provider types must have compliance plans in place and what those plans must entail. HHS has informally indicated that it would likely roll out the compliance plan requirements on an industry-by-industry basis. It is likely that the requirements for most industries will closely follow the key components of the DHHS Office of Inspector General model compliance plan published for healthcare providers in 1997, which has subsequently been updated.

For healthcare providers without compliance plans that wish to make early moves toward a full compliance program, or for buyers who seek additional comfort through early implementation, an article entitled “A Practical Compliance Plan Approach for ASCs” authored by Scott Becker, Melissa Szabad and myself is available here. Although this article speaks specifically to the ambulatory surgical center industry, it has practical implications for most healthcare providers. 

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On Wednesday, March 12^th, McGuireWoods hosted our 8^th Annual Business & Legal Issues in Dialysis & Nephrology Symposium. Leaders from various perspectives in the industry provided presentations and lead discussions on a wide array of topics, including the effects of the Patient Protection and Affordable Care Act (the PPACA, commonly referred to as the Health Care Reform Law), key compliance issues and investment scenarios.

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In recent years there has been growing public awareness of end of life decisions and the importance of documenting advance healthcare decisions. In fact, April 16^th is National Healthcare Decisions Day, a nationwide educational event founded by McGuireWoods partner Nathan Kottkamp.   Advance directives are legal documents, prepared by patients in advance of the need for healthcare services, that directs the healthcare the patient does or does not want if he or she becomes unable to make decisions. Advance directives may include durable powers of attorney, living wills and organ donation directions.  Nathan recently discussed advance directives, including issues arising out of healthcare reform debates, on Countdown with Keith Olbermann. 

From the perspective of many healthcare providers, providing information about advance directives is required by law. The Conditions of Participation in the Medicare and Medicaid programs require hospitals, critical access hospitals, skilled nursing facilities, nursing facilities, home health agencies, providers of home healthcare (and for Medicaid purposes, providers of personal care services), hospices, ambulatory surgery centers, and dialysis facilities to inquire about and provide information to patients regarding advance directives. Further, the Conditions of Participation require all of these healthcare providers, except ASCs and dialysis providers, to provide public education about advance directives. Additionally, healthcare accreditation bodies Joint Commission and AAAHC have accreditation standards requiring facilities to honor advance directives.

In connection with the national focus on advanced healthcare decisions, new companies have emerged to assist patients and healthcare providers with the advance directives process. Embark Health, for example, has developed and is actively distributing Advance Directive Solution (ADS), a comprehensive online and telephonic resource with all the information and legally current forms to create an enforceable advance directive. Embark Health is also in the process of rolling out The Personal Legacy Solution (PLS), an electronic repository for tracking the location of assets, the location of other important items or documents, and for storing important messages to loved ones (all of which will be retrievable in accordance with the individual member’s specifications).  Embark Health markets these products directly to patients as well as to and through large systems such as health plans, hospitals and other providers. Burgeoning companies like Embark Health and others may provide an opportunity for investors interested in healthcare and healthcare IT services.  

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