The Effects of the New Medicare Reimbursement Methodology on ASC Partnership Share Value

The Centers for Medicare and Medicaid Services (CMS) has issued its long-awaited rule on the ambulatory surgery center (ASC) payment system and it will have a significant impact on ASCs in which physicians invest and utilize. Linking the ASC and hospital outpatient department (HOPD) reimbursement methodology is the overriding theme of the rule.

Based upon the methodology established in the final rule, CMS estimated that ASC reimbursement rates for 2008 would be 67 percent of the corresponding HOPD rate for the same procedure. However, this percentage was determined using 2007 HOPD rates. Based upon CMS’s proposed 2008 HOPD rates, ASC rates would actually be 65 percent of HOPD rates. CMS is phasing in the new rates over a four-year period. CMS will adjust ASC payments each year to reflect changes in technology and resources used in performing procedures. In 2010 and beyond, the ASC conversion factor will increase by an amount equal to the U.S. consumer price index (CPI) for urban consumers.

These changes established in the final rule will have significant effects on the cash flow generating potential of each ASC and will likely affect the value of ASC partnership units owned by physicians, hospitals and third parties.

The value of an ASC depends on future cash flow (distributions) available to shareholders and volatility or risk associated with future cash flow. There are a myriad of factors that can affect the future cash flow of an ASC. They include, but are not limited to the following:

• Physician ownership concentration 
• Competition in the service area 
• Case volume and mix 
• Payor mix and concentration 
• Staffing levels 
• Supply costs 
• Occupancy costs 
• Capital expenditure requirements 
• Medicare reimbursement methodology 

In addition to these factors, each ASC’s risk profile is unique. For example, if an ASC with a small number of physician owners has two of its high case volume physicians nearing retirement, the ASC will have a higher risk profile — and therefore deserving of a lower value — than an ASC with similar economic characteristics but a large diversified base of physician ownership with physicians in various stages of the practice cycle.

Considering the lengthy list of factors that affect ASC share value, it is important to understand that Medicare reimbursement represents just one of many factors — albeit an important factor — that affect ASC value. When applying the fundamental valuation principles of assessing cash flow and related risk related to the new CMS payment methodology, it is important to consider the following new factors triggered by the CMS rule:

Defined Payment Methodology: The final rule communicates the payment methodology to the marketplace so that ASCs can adjust to the new payment realities. The Medicare payment changes will have a slight negative effect on ASCs that focus on certain specialties (such as gastroenterology or pain management), although the effect is not as drastic as initially proposed in August 2006. CMS has provided a transition period of four years that will help allow management of the ASCs that face declines to gradually adjust to the new payment system. Since the effects of the rule are now known and time will be given for ASCs that are affected negatively to adjust their operations, this decreases uncertainty of future cash flow and lowers risk.

Pricing Growth: We have seen HOPD payment rates consistently increase over the past several years as Medicare ASC rates remained frozen due to the Medicare Prescription Drug Improvement and Modernization Act of 2003. Since ASC shares are valued based on future cash generating potential, growth in reimbursement is an essential factor affecting future cash flow. Without annual updates in pricing, revenue cannot match normal expense growth and profit margins contract over time. CMS’s decision to link ASC and HOPD reimbursement changes dramatically increases the likelihood that ASCs will receive annual reimbursement updates from Medicare. The rule links ASC reimbursement growth to the Urban Consumer Price Index, which has increased between 2.5 percent and 3.5 percent annually over the last few years.

Increased Payment Complexity: The nine grouper payment methodology has historically assisted in leveling the playing field between independent ASCs and third-party payors due to its simplicity and widespread application in commercial payor contracts. Considering the significantly increased number of procedure classifications and complexity of the new reimbursement system, it is likely that payors will work to decrease payments to ASCs over time by emulating the Medicare methodology selectively and to their advantage. Thus, the new system not only gives third party commercial payors an advantage in claims processing, but it will also build on payors intrinsic strategic advantages over ASCs in information technology sophistication.

Increase in Procedures: The CMS rule includes 790 new allowable procedures. Many of these new procedures are currently performed in the physician office and are low reimbursement cases under the new system, so it is unlikely that ASCs will benefit significantly from these procedures. Experts estimate that this increase in procedures will add less than 1 percent to revenues for ASCs over the next two to three years.

Factors’ Effect on Risk and Value 

The following table summarizes the effects of the changes brought about by the new Medicare payment system on the risk related to the future cash flows of a typical ASC and therefore the value of ASC partnership shares:

Understanding that each ASC is unique, the best method of accurately assessing an ASC’s value is a thorough valuation analysis performed by an independent third party that takes into account the fundamental characteristic and future prospects of the ASC and incorporates the effects of the new Medicare system based on the ASC’s case mix. The valuator will utilize a discounted cash flow analysis where the objective is to determine the value of the business given the cash flow generating potential of the ASC adjusted by growth and risk characteristics.

As the table illustrates, the CMS rule is a mixed bag for ASCs. All other variables held equal, the effect on ASC partnership share value depends on the ASC’s specialty mix and the ability of ASC management to adjust to the new methodology. The effect of decreased reimbursement in some ASCs and increasing complexity are counterbalanced by decreased uncertainty due to the defined methodology, annual updates and an increase in allowable procedures. When assessing an ASC’s value, it is crucial to thoroughly analyze the individual ASC’s facts and circumstances and factor in the effects of the new rule on the ASC’s future business prospects. o

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