Why hospital-doctor joint ventures are in jeopardy

One of the most pressing issues in health care today is cost containment. Hospital-physician joint ventures, created during the late 1970’s and 1980’s to increase revenues, maintain market share and increase levels of profitability, are coming under increasing scrutiny in an effort to reduce health care costs. The focus of the scrutiny is the physician referral to an entity in which the physician has a financial interest.

Hospital-physician joint ventures range from developing and managing medical office buildings to purchasing equipment. The joint ventures typically were formed with the physician-investor supplying the capital for the joint venture and the hospital providing the management expertise.

The joint ventures allowed hospitals to increase their service capabilities by purchasing new equipment with less financial risk. Physicians benefited from the joint ventures which provided a means to pool resources to develop and manage diagnostic centers and outpatient centers and outpatient centers which could have been impossible for a single group practice. Proponents also argue that the joint ventures between hospitals and physicians control costs by increasing operating efficiencies and better maintain utilization of medical resources.

However, the environment for hospital-physician joint ventures has changed dramatically over the last few years. The joint ventures have undergone increased scrutiny due to legal and ethical considerations of physician referrals to health care facilities in which the physician has an ownership interest.

In July 1991, the U.S. Department of Health and Human Services (HHS) issued its “safe harbor” regulation which narrowly defines the permitted self-referrals. Last March, the HHS Departmental Appeals Board remanded the landmark case The Inspector General vs. The Hanlester Network back to the administrative laws judge with instructions to narrow the test for the legality of the joint ventures with physician investors. In addition, the Internal Revenue Service, in a coordination of objectives with HHS, issued General Council Memorandum 39862 in November 1991, which linked the tax-exempt status of a hospital to its compliance with the anti-kickback states and “safe harbor” regulations of HHS.

As if the governmental regulations weren’t limiting enough, the American Medical Association’s council on Ethical and Judicial Affairs has recommended that physicians not refer patients to entities in which they have an investment interest if the entity is outside the physician’s office and the physician does not directly provide care at the facility. While these actions seem to ring the death bell for hospital-physician joint ventures, they are designed to limit any potential abuse of physician self-referrals rather than limit any potential advantages of physician-hospital relationships.

HHS was mandated by congress to develop a list of business practices among health care providers which would not be subject to prosecution by the federal government under the anti-kickback statute. These rules or “safe harbor” standards were made public in July 1991. One of the most wide ranging business practices affected by the safe harbor rules, in order to be shielded from prosecution under the anti-kickback statutes, 60 percent of the capital investment in any joint venture must be from non-referral sources (both hospitals and physicians are considered referral sources) and 60 percent of the revenue of the joint venture must be from non-investors. Most of the hospital-physician joint venture ads currently structured do not meet this 60/40 test.

In addition to the 60/40 test, the safe harbor regulations have several other standards which affect hospital-physician joint ventures. These standards limit any preference for referrals as a basis of a physician investor profiting from the investment.

One interesting provision of the safe harbor regulations is that the purchase of physician practices by hospitals is not included under the safe harbor provisions. Some health care experts feel that unless some flexibility is allowed for hospitals to purchase physician practices, the quality of primary care may be affected in rural areas which traditionally have difficulties recruiting physicians.

Hanlester Network provides the first landmark test of whether hospital/physician joint ventures violated the Medicare anti-kickback statutes. The case involves a joint venture between SmithKline Beecham Clinical Laboratories and about 100 physicians in an investment in a network of three laboratories.

In March 1991, the administrative law judge in the case ruled that the joint venture did not violate the anti-kickback statute since there was not an implicit or explicit agreement of the physician to provide referrals. However, the Office of Inspector General (OIG) appealed the ruling to HHS Department Appeals Board (DAB) which remanded the case to the administrative law judge with instructions to narrow his interpretation of the term “inducement.”

The administrative law judge partially reversed his original decision and found that three labs violated the anti-kickback statutes. Among the primary reasons for violation, in the judge’s opinion, were that the rates of return on the investment in the joint venture with the laboratories were indirectly linked to the number of referrals by the physicians. Also, payments to the physicians were based upon expected rather than actual receipts. The case is expected to be appealed to the DAB and eventually resolved in the federal courts.

The IRS position on hospital-physician joint ventures was clarified with the release of a recent General Counsel Memorandum. The memorandum, which was issued in November 1991, states that the Service will examine closely tax exempt health care providers to determine if the provider is in compliance with the safe harbor regulation and the anti-kickback statutes. If the provider is found to be in violation of either the regulation or the statutes their tax exempt status will be in jeopardy.

However, the IRS will look favorably on any joint venture that provides a clear health care benefit to their communities and involve a sharing of risk and rewards of an investment in the joint venture. The IRS gave a grace period until September 1, 1992 for hospitals to unwind joint ventures before the Service implements an aggressive enforcement policy.