Dissecting the Medical Practice Revenue Stream—Part 1

Four things valuators should know about medical claims and coding

While all valuators need to be able to cite specific factors considered in the determination of fair market value, many times the measures selected could be applied to a variety of industries. In this first of a two-part series, Jeffry Moffatt examines why revenue is most often a primary area of interest for valuation, because without revenue, there can be no cash flow. However, not all revenue streams are created equal, and therefore, specialized knowledge of certain industries is needed to qualify the underlying value of cash flow. The healthcare industry is a great example of the need for specific industry expertise.

Dissecting the Medical Practice Revenue Stream

Widespread and highly debated regulatory changes in the healthcare industry (e.g., the Patient Protection and Affordable Care Act (ACA), the HITECH Act, the Sustainable Growth Rate, etc.) have driven a wave of consolidation, joint venture activity and strategic alignment over the past several years.  Due to federal regulations such as the Stark Laws, the Anti-Kickback Statute, Civil Monetary Penalties, and other authoritative guidance regarding transactions between certain healthcare entities, valuators are often relied on in these instances for purposes of determining fair market value.  While all valuators need to be able to cite specific factors considered in determination of fair market value, many times the measures selected could be applied to a variety of industries.  Revenue is most often a primary area of interest for our profession, because without revenue there can be no cash flow.  However, not all revenue streams are created equal, and therefore, specialized knowledge of certain industries is needed to qualify the underlying value of cash flow.  The healthcare industry is a great example of the need for specific industry expertise. 

For healthcare valuators, understanding the medical practice revenue stream is perhaps the most crucial, since much of the current activity in the industry generally revolves around either:  (a) acquisitions of medical practices or outpatient facilities by not-for-profit hospitals or other regulated health systems, or (b) agreements between said hospitals and health systems and physicians belonging to a medical practice or facility.  Valuing such transactions and analysis of the revenue streams, as applicable and appropriate, is based on a sound understanding of medical claims and coding.  The claims submission process and the coding that documents each medical claim is the primary method of collecting payment for most services provided in the current healthcare environment (i.e. “fee for service”).  A valuator’s ability to dissect this process helps to identify those specific factors that contribute to fair market value.

The following list includes some of the unique circumstances of the medical practice revenue cycle that affect cash flow, and how they relate to the valuation of a medical practice:

1) Virtually every transaction involves more than just a buyer and seller

Payment for an office visit will generally include a beneficiary (the patient), a provider (the doctor), and a payor (the patient’s health insurance company).  In some cases, the beneficiary may have a payment due at the time of service, which generally will consist of an insurance co-payment amount and/or the patient’s portion of his or her insurance policy’s annual deductible.  The remainder due is submitted to the payor for payment to the provider. 

The way this process affects cash flow relates to the way that these various components of payment for service are collected.  For example, a typical fee for an office visit may be $100 with an insurance co-payment of $30. An additional percentage of the overall fee may be payable by the patient that is applicable to an annual deductible (assume 25 percent or $25), and the remainder of the fee is generally payable by the payor.  Ideally, a practice will collect the patient’s responsibility (co-payment and deductible, or $55 in this case) for payment at the time of service; however, many times this is not the case since it may be difficult for the patient and the practice to know what this exact amount due is until it is verified with the payor.  Some practices have a “pre-certification” process in place to determine the patient’s responsibility in advance, but this requires additional time to verify on top of the time needed to submit the actual claim.  Additionally, it may be the case that the services actually provided differ from what the provider initially expected and pre-certified and as a result, the payment actually due may vary. 

As a result, many practices go through this process after the patient has been seen and when the actual claim is submitted to the payor.  If the patient’s responsibility is effectively and efficiently collected after the time of service, this impact of billing patients for co-pays and deductibles is likely minimal; however, it is often, at least to a small extent, more difficult to collect payment from individual patients after the fact, and the time to collect may have a material effect, as well.  If we assume that a given practice may see 20,000 patients per year and that 10 percent of these patients do not pay their portion of the practice’s fee (in our example, $55), the net impact could be $110,000 of cash flow. 

Additionally, many employers are adopting high deductible health plans (HDHPs).  In these cases and based upon our example office visit, the patient is responsible for 100 percent of the fees until an annual deductible is met; therefore, in our example, the entire $100 fee could be payable by the patient.  If we assume that 20 percent of the same practice’s health plan beneficiaries participate in HDHPs, then the net impact of uncollected co-pays and deductibles (assuming ten percent again) could increase to $128,000 of cash flow.

A detailed analysis of patient accounts can aid the valuator in determining if the impact of a practice’s patient balance collection policies may be impacting cash flow outside of industry or market norms.  In our example above, we’ve illustrated the total impact to cash flows, which would imply that normally all co-pays and deductibles are collected.  In actual practice, this number would be adjusted to reflect a normalized non-payment benchmark percentage specific to the practice’s demographic.  An aging of accounts receivable attributable to the patients’ payment obligation may provide insight of how a normalized estimate of collections of these amounts may impact working capital or the value of the accounts receivable themselves.

2) Submitted claims undergo heavy scrutiny

Medical claims are routinely reviewed by payors to verify that the services provided are documented correctly and “medically necessary.”  This process includes a review of the “coding” used to indicate which services were provided.  In most medical practices and outpatient facilities, the convention used is current procedure terminology (CPT) coding, issued by the American Medical Association (AMA).  In general terms, payors will compare the CPT codes utilized to the services documented to determine if payment should be made.  Denied claims can sometimes be re-submitted with additional documentation; in other cases, claims are simply found not to be eligible for reimbursement.  Routinely denied claims can be an indication of poor documentation by the providers and, depending on how accounts receivable are recorded, can increase the practice’s claims’ days in account receivable and overstate total accounts receivable. 

Recovery audit contractors (RACs) were introduced in the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (MMA) by the Department of Health and Human Services (DHHS) in an effort to curb expenditures related to the Medicare Fee-For-Service program.  RACs are entities independent of Medicare, and at the most fundamental level, RACs have been contracted to:

• Detect Medicare underpayments and overpayments; and
• Repay money to a provider who was underpaid; or
• Collect money from a provider who was overpaid

RACs are paid a contingency fee based upon the amount of the improper payments they correct for both overpayments and underpayments.  As one may imagine, the general consensus within the industry is that RACs’ primary focus is on the recovery of improper payments.  Overpayments by type in 2007 were as follows:

• 32 percent—medically unnecessary service or setting
• 42 percent—incorrectly coded
• 9 percent—insufficient or missing documentation
• 17 percent—other

As Medicare typically represents a significant portion of a practice’s patients (35-40 percent is not unusual), these payment recoveries and the related appeals process can be cumbersome and costly.

In healthcare valuation, we evaluate the potential for these types of payment recoveries—regardless of whether dealing with Medicare or other payors—through “chart audits.”  In a chart audit, a random sampling of patient charts are reviewed for: (a) the appropriateness of the CPT codes utilized based upon the documentation in the chart, and (b) to determine if the documentation in the chart supports billing for additional services not already represented by a CPT code.  Assume that in our prior example practice that an audit reveals that a sample of charts is accurate 90 percent of the time with a net impact of the instances of over-coding and under-coding of $50 per claim.  The extrapolation of these findings over the practice’s 20,000 patients could be $100,000 of annual cash flow.

View Part 2 here.

Jeffry M. Moffatt, CPA/ABV/CITP, CVA, is a manager of Blue & Co., LLC’s Valuation and Healthcare Group.  Jeff is based out of the Indianapolis office and works primarily with hospitals and health systems in the development of physician alignment strategies and employed physician group consulting.  He also assists clients in data analytics and business intelligence implementation for hospitals, physician practice groups, and outpatient facilities. Jeff can be contacted at jmoffat@blueandco.com.