The contracts that were completed and executed three to five years ago are approaching their renewal dates. Most of those first-generation contracts were between health systems/hospitals and physician groups under the auspices of productivity-based models. While those contracts did move the dial toward the physicians being at risk or having less guaranteed pay, they mainly focused on individual and/or group productivity; the measurement of that productivity was almost always in work relative value units (wRVUs).
Now, years later, as these original contracts are up for renewal, the negotiation process takes on a whole new look. Although productivity is still the focal point of these second-generation contracts, there are other matters to consider based on the lessons learned from the first-generation transactions.
The negotiation process is entirely relevant to these changes, some of which are obvious and others more subtle, yet negotiators of these renewal agreements, whatever their perspective, must be well-versed in the positives and negatives of the original contracts, as well as the current and impending industry changes.
In this article, we consider the essential tenets of the negotiation process relative to the second-generation alignment contracts. First, we discuss the critical issues in the process, followed by a review of the major components. Finally, we cover the keys to a successful second-generation transaction.
LESSONS LEARNED AND KEY NEGOTIATION CONSIDERATIONS
As noted, recent events in the healthcare marketplace/industry have had an enormous effect on second-generation contracts. It is necessary to have a thorough understanding of where the industry has moved since the negotiation and finalization of the original transaction, and the direction that we anticipate we are heading before the expiration of the first-generation deals.
Consequently, several significant points must be addressed before entering the second-generation negotiations.
Original contract positives and negatives. A variety of first-generation deals exist today. Some emphasize workflow and the assignment of duties as opposed to a required level of productivity. Those contracts guarantee all the compensation to the providers as base pay; however, even more existing contracts place emphasis on productivity as measured in wRVUs. The wRVUs are converted into compensation, usually based on a specific amount per wRVU and other key areas tied to financial performance.
For example, many wRVU values relate to costs based on the conversion factor of the previously private practicing physicians’ actual wRVU take-home pay (that amount relates to the overhead of the practice). Others emphasize a combination of productivity- and non-productivity-based incentives, but in the final analysis, nearly all the first-generation contracts place the providers at risk for their productivity and the resulting compensation.
Realistically, these models could be interpreted as both pluses and minuses. Productivity is not a negative aspect of compensation when applied within proper legal and ethical parameters; however, as we move to a more value-based reimbursement system, the viability of productivity-based first-generation contracts becomes less sustainable. What was once a positive facet of contracting might now be construed as a negative.
Other pluses and minuses of each first-generation contract should be reviewed. It is the responsibility of both parties (i.e., the employer and the employee), and possibly an outside consultant/advisor, to analyze and evaluate the positive and negative aspects of the first-generation contracts to implement improvements in the second-generation negotiations.
Changes in the reimbursement paradigm. Clearly, past and future changes have a major effect on the second-generation contract negotiation terms and conditions. As we move from volume to value reimbursement, the incentives must change along with the financial/economic structure of the agreements. The contract negotiations must consider the impending changes, no matter the perspective (i.e., employer or employee). For example, as the bundled payments of reimbursement start to take shape, the metrics used to allocate monies from within the bundle to various providers are relevant to the contract going forward.
Structural changes. Models of alignment vary. Whether they are employment or even what we often call “employment lite” (i.e., professional services agreement [PSA] contracts), their structure going forward is relevant. We often are asked whether the financial terms should vary from a PSA to an employment model, and especially how they would be affected from the standpoint of a fair market value (FMV) or what is commercially reasonable (CR). In general, it should not matter whether the structure is a PSA or employment; the financial terms apply from a compliance standpoint with no difference in equivocating FMV and CR rates.
However, structural changes are occurring within the second-generation models. For example, employment was often the original model, and it continues in the second generation, but many health systems recognize the value in allowing larger groups to remain autonomous and independent, especially in the day-to-day management.
A model demonstrated in the second-generation contracts is the group practice subsidiary (GPS) model. While a legal subsidiary may or may not be created, the group may be structured and function as if it were a separate subsidiary with substantial day-to-day autonomy. Technically, all the providers, staff, etc., are still employed, but this structure is defined better within second-generation models, as the negotiation process reflects. (Note: Although the purpose of this article is not to sort out the various structures in second-generation models, we should consider revisions to the structure in the context of the overall negotiations.)
Changes in terms and conditions. The terms and conditions, often referred to as the mechanical or technical areas of the contract, may relate to various details about the term, renewal options, termination rights, restrictive covenants, exclusivity, indemnification, and myriad definitions and conditions to consider in the second-generation contract.
Although these issues were a part of the initial contract, the basic requirements must be revamped. They must reflect the structural, reimbursement, and compensation changes, as well as address the necessary adjustments in the relationships to meet the needs of the marketplace and to fit the current and future reimbursement parameters.
Although the economic terms and revisions, in addition to governance and leadership changes, are of the highest interest, contract renegotiations should also consider the basic terms.
Leadership and governance. New contracts should be expected to reflect changes in leadership and governance rights and obligations. The GPS model, noted above, is an example of how many groups are gaining more autonomy in day-to-day management and oversight. Likewise, PSA models typically entail a management committee comprising both health system and practice representatives (usually on an equal footing), with that committee as the governance and leadership body that oversees the PSA on a month-to-month basis.
These types of arrangements should be investigated in the second-generation negotiations to ensure all areas are covered, particularly with the changes under study for the second-generation contracts (i.e., structure, reimbursement, compensation incentives, terms and conditions, etc.).
Corporate considerations. Whenever a health system and a practice are fully aligning through employment or PSA, another consideration is the overall corporate oversight and management involvement within the health system, which reflects on the cost allocations from the corporate management component of the health system down to the practice level.
All matters should be analyzed from an economic, governance, and leadership standpoint. The second-generation contract negotiations must consider any changes in the corporate structure since the initial contract negotiations and address them as appropriate.
Regardless of the perspective, many elements must be considered and revised in the second-generation contracts and in the negotiation process in both economic and non-economic terms. The review calls for a systematic and organized process that examines all the key points. One method is to develop a simple matrix, or issues tracker, to document the issues. This tool will provide an organized effort from the perspectives of both sides to address all the issues; it also helps to identify those concerns that are most pressing and challenging.
THE NEGOTIATION PROCESS
The actual negotiation process for second-generation contracts is similar to any other contract; however, the focus is on the key areas of consideration discussed in the previous section of this article. The following are descriptions of the specific tools to facilitate the negotiation process.
Financial analysis. Every negotiation process should encompass a thorough financial analysis, which should be completed by an independent party/consultant on behalf of either or both sides of the negotiation. Preferably, each party should provide its own outside assistance to formulate its financial analysis. In some cases, hospitals will complete this analysis with their in-house financial department, but obtain outside help if necessary.
Such a report will assimilate the main components of the economic terms going forward and will serve as a basis for determining the parameters of FMV and CR rates. Further, it can clarify the health system’s return-on-investment parameters and most economic forms of payment.
This financial analysis should be developed in some detail, comparing historical performance during the first-generation contract life in terms of productivity of the providers (dollars and wRVUs), cost/overhead, and ultimately, the compensation derived.
The health system must be careful not to tie any value of the downstream revenue to the physicians’ compensation in the second-generation contracts. This factor should not be a part of the financial analysis.
Issues tracker. The issues tracker is valuable for the overall negotiation process. The issues tracker is an organizational tool that, as the negotiations move along, will eliminate resolved areas and allow the parties to focus on those issues that remain.
Letter of intent. The letter of intent (LOI) is an important document in that it encapsulates all the key terms and conditions — both economic and non-economic — relative to the second-generation transaction. It should be updated as issues are resolved and may be used in a tracked form to identify the changes and to maintain a document that will ultimately be used to draft the definitive agreements.
Definitive agreements. Once the issues are resolved and the LOI agreed upon (if not fully executed), the final agreements will be drafted. Depending on the structure of the second-generation alignment, the definitive agreements may entail nothing more than an employment contract or a PSA contract, which might include an asset purchase agreement. In more complicated cases where management services are being provided by the practice, there may be a practice support services agreement (PSSA). Also, at times, there may be a management services agreement (MSA) that outlines the standard terms and conditions.
The negotiation process should involve a variety of tools, including documents that support the negotiations as a “work in process,” working toward the final definitive agreements. These tools and a tightly maintained organization are assembled for navigating the second-generation negotiation process.
KEYS TO A SUCCESSFUL SECOND-GENERATION TRANSACTION
Other overarching points of consideration that lead to successful negotiation of the second-generation agreement are as follows:
Understand the process and the overall flow of negotiations. The negotiation process is both an art and a science in that both parties should be willing to do what it takes to complete the transaction. Often, it takes time and a spirit of “give and take” to work through some of the most difficult issues; therefore, the issues tracker is important to improving the efficiency of the process and to zeroing in on the crucial areas of difference. Another means to help the parties strike a deal is to have a healthy respect for the ebb and flow of the negotiation process, with neither side overreacting or getting too caught up in the other side’s positions.
Also, it is important to engage outside advisors, including healthcare consultants and attorneys. These are professionals who will separate the personal (and even emotional) feelings that are inevitably at play between the two parties of the transaction. A primary objective of developing these second-generation contracts is to address all areas, even the more difficult ones, while not generating negative feelings in the working relationship, post-transaction.
Respect the changes in the industry. Many people falsely assume that, based on the first-generation contract, the second-generation deal should be easy and without major hiccups. Because of the striking changes in the healthcare industry that must be factored into the second-generation contract, this assumption is unrealistic.
That these adjustments are happening slowly is a factor that becomes even more challenging as the second-generation contract negotiations continue with a near-term effective date. In contrast, the effect on the new contracts is minimized by the modifications in the industry (such as volume-to-value reimbursement), which are far from fully defined and much less established.
Delineate the key needs and expectations of both parties. Sometimes, the unstated or less-than-fully-explained points lead to the greatest areas of confusion, distrust, and polarity. Thus, it is important that both sides fully articulate the crucial areas relative to their needs and expectations, perhaps even to the point of drawing some lines in the sand. A lack of clarity tends to breed distrust and uncertainty, which has the potential to undermine the transaction. It is essential to have a precise definition of each side’s position, along with a spirit of compromise.
Create a negotiation subgroup. Depending on the size of the organizations, it is much better to “boil down” the negotiation process to a smaller group of representatives from both sides and, except for outside advisors/legal counsel, be limited to decision-makers or their designees within each organization. Those who are designated to represent the decision-makers should have close access to those who can make decisions rapidly.
Using a subgroup process is efficient, and it allows for better timing and an enhanced approach toward completion. Those who are within the direct negotiation subgroup should communicate to others in their organization, keeping them informed of the negotiation process and obtaining direction and supervision, as applicable.
Avoid misunderstandings at all times. The likelihood of misunderstanding and delay (and possible failure) of the negotiation process is high without the documentation of those things that have been agreed upon (using an issues tracker tool and/or recording in an LOI). The negotiation is a spirited process that often results in amplified emotions and, because so much of the discussion involves economic decisions projected over many years it rightfully takes on added significance. In short, proper documentation eliminates misunderstandings.
This same caution goes for mixed messages that include incomplete responses or, perhaps worse, incomplete answers to all points. (For example, if a party is not ready to respond to a particular point in the negotiations, they should acknowledge that they are not ready rather than pass over and ignore the matter.)
Allow for changes post-transaction. No one knows how the future of healthcare and reimbursement structures will unfold and what issues will be pertinent to the second-generation alignment contracts. It is wise, therefore, and essential, perhaps, to allow for some areas of change and/or adjustment as the industry sorts through various issues and clarifies what will transpire. This flexibility particularly pertains to the reimbursement structures and how fast we will move away from fee-for-volume versus fee-for-value. Then, how soon will we need to adjust the compensation incentive structures of employed or contracted providers with health systems and/or other entities?
Often, the agreement stipulates that if a certain percentage of the total reimbursement changes, further discussion and the possible reopening of negotiations for revisions to the contract is all that is necessary to occur. Moreover, rather than forcing an overnight change, adding a requirement for some form or timeframe for transitioning is entirely appropriate.
CONCLUSION
The keys to successful negotiation of the second-generation contract may ultimately be summarized in a simple statement: The process should be collaborative, communicative, and transparent. With these characteristics in play, along with a give-and-take spirit by both parties, the likelihood of a successful second-generation contract increases.
Excerpted from Physician-Hospital Alignment and Compensation Models: The Second Generation by Max Reiboldt, CPA; Justin Chamblee, MAcc, CPA; and Ellis M. “Mac” Knight, MD, MBA, FACP, FACHE, FHM.