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

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  A decade later, Congress allowed the federal law to expire, and several states quickly repealed or let sunset their CON laws.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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