David J. Schiller, J.D.
Though it is still months before the initial direct financial impact of the Relative Value Based System (RVBS) becomes evident, their indirect impact has already been felt by some practice owners. While many practices are looking ahead to January 1992, when the first phase of the actual changes take effect, the anticipated changes in net income are already translating into declines in the anticipated goodwill value for some medical practices.
The changes are scheduled to take place over a four-year period commencing in 1992. Although some of the actual alternative rates were just published, the information from Health Care Financing Administration leaked earlier indicated the severity of some cuts and the impact upon particular specialties hit hardest. It is believed that anesthesiology, ophthalmology and cardiothoracic surgery will be hit the hardest with cutbacks averaging 35%. The cutbacks are aimed at procedure-oriented specialties. For example, insertion of a pacemaker, which is reimbursed at $818 today, will be cut back to $491 by 1996. Similarly, a hip and joint replacement, which is currently reimbursed at $2,111, will be cut back to $1,486 by 1996.
Even before inflation, these cuts are quite significant. The cutbacks aim to compensate for past inequities between the primary care specialties and the procedure-oriented specialties. The new relative value rates are supposed to be based on the amount of work involved, practice overhead based upon the physician’s geographic region and malpractice insurance premiums in the geographic region. The result is that family practitioners and other primary care specialists will see reimbursement increases of 15% based upon Medicare charges.
It is widely anticipated that most other third-party payers will quickly follow the relative value based payments, particularly since this should result in them saving money. In Pennsylvania and other states, when automobile tort reform was put into law, medical injuries resulting from accidents were reimbursed based on Medicare payments. It is anticipated that the same course will follow when the Relative Based Value System is implemented.
The value of goodwill in a medical practice is a hotly debated topic. Younger physicians joining practices typically believe that it is worthless yet still see the wisdom and merit of joining an established practice. Physicians that own practices believe that theirs are the premier practices in their areas and have tremendous goodwill value, far exceeding an average practice.
Goodwill Values Hard to Determine: Unfortunately, unlike the sale of an automobile or piece of real estate, the value of the goodwill portion of a medical practice cannot easily be determined. Although many “experts” will charge you a fee and come up with a value, in the final analysis, the subjective criteria used can at best give a ballpark value to start negotiations. In the past, most attorneys and accountants have recommended using a percentage of the practice’s gross receipts or net receipts to determine a reasonable goodwill value. The better analysis typically focuses upon the practice’s net income. Although gross income looks fine on paper, if overhead is disproportionately high, the gross receipts figure may be deceiving. In addition, the primary focus is typically on how much compensation (and benefits) should be anticipated in the future. No one will pay a significant goodwill value for below-average income.
No one doubts that for most specialties the relative base value system will result in a significant change in income for many specialties. Unfortunately, unlike when a physician slows down and reduces volume, when procedures simply yield less money, overhead of the practice does not drop ratably. If one works just as hard and the cutbacks result in less gross income, the net income should drop almost on a dollar for dollar basis. Overhead will quickly climb in relation to net income. Just like any other business, your practice’s value will decline if net income declines.
At the time of a buy-in, the owners and non-owners typically negotiate and agree upon a goodwill price. It has typically been premised upon the net income, per physician, increasing annually by factors far exceeding inflation. Based on the history of the practice, it was easy to predict continually increasing net income and reasonably establish an affordable price.
In the past 6 months, we have noticed numerous younger physicians citing the Medicare cutbacks in justifying their agreeing to little or no goodwill value recognized in the sale price of a practice.
Owner-physicians have responded to these concerns in various ways. Some have dismissed the younger doctors or simply allowed them to remain as non-owner employees. This is the my-way-or-no-way approach. Others have devised compromises that give them a reasonable goodwill value, while contractually guaranteeing the ongoing success of the practice. One structure is to use a traditional phase up of net income that self-adjusts based upon the success of the practice. For example, when the younger physician receives 60% of a full share, if the practice is more successful and the full share is larger, the senior doctor will receive more money.
An alternative is to have the younger physician pay a specified amount each year until he has paid for his interest in the practice. If the arrangement is set up as a fixed dollar amount, this can be done in tiers so that only a portion of the amount paid is definite and the balance is paid only as certain income thresholds are met by the junior doctor. This essentially makes the price of the practice self-adjusting based on its success. Most younger physicians do not mind paying a reasonable price as long as they are earning a sufficient income to justify the higher goodwill value.
Despite the utilization of inventive approaches in dealing with the problem, it seems that the high goodwill values of the past years are apt to decline as practice incomes stabilize or decline.
David Schiller is a Philadelphia attorney who specializes in taxes and pension planning for physicians.
PUBLISHED IN: BUSINESS PLANNER
Copyright © 2017 SCHILLER LAW ASSOCIATES. All rights reserved.