Few subjects have provoked as much passionate debate in the health care valuation community as relying on the asset approach as the sole basis for a conclusion of physician practice value when the income approach indicates no supportable intangible value, including the value of a trained and assembled workforce. A new white paper, Intangible Asset Valuation, Cost Approach Methods and Procedures, authored by highly regarded valuation expert Robert Reilly and published by the AICPA, is a much needed and generally well-written technical resource on the application of cost approach methodology to the valuation of intangibles.
The white paper explains common reasons for valuing intangibles and provides comprehensive categories and lists of intangible assets, both in general and specific to the health care industry. The paper outlines the critical appraisal practice of considering the three broad approaches to intangible valuation: the cost, income, and market approaches. Also included is specific “how-to” advice on cost-to-replace methodology under the cost approach, applied in the context of a hypothetical example of a “fairly large internal medicine practice” being targeted for acquisition by a local non-profit hospital.
Where the white paper falls short, however, is in addressing the longstanding debate over application of the asset approach in valuing physician practices, including intangible workforce value, when the income approach does not support the value of intangible assets. The white paper does, however, address situations in which the asset approach value exceeds the income approach because of a failure of the valuation to recognize economic obsolescence in the cost approach valuation of the intangibles.
Essential to the workforce debate is the matter of post-acquisition physician compensation and economic returns accruing to the hypothetical buyer – in actual practice, hospitals. Does the buyer experience any ROI on this workforce asset when all the returns are paid out to the physician-employees? Several colleagues and I participated in an earlier white paper on the subject that addresses these questions in 2011, found here.
Regulatory challenges and health care valuation
Another topic notably absent but vitally important, especially in light of its fair market value definition and applicability to the subject matter of the paper, is the Stark law. This anti-fraud law prohibits a physician from making a referral of certain services payable by Medicare to an entity with which the physician has a financial relationship (unless an exception applies) and prohibits the entity from presenting claims to Medicare for those prohibited referrals. There are several key exceptions to the Stark law, including a requirement that the financial arrangements are consistent with fair market value. To miss the mark in this key component of a Stark exception exposes the parties to potentially staggering fines and penalties if found liable as part of a qui tam or government enforcement action.
Vetting the Valuators
Recent settlements as high as hundreds of millions of dollars underscore the risks of violating federal health care laws and regulations that govern hospital/physician relationships, and many elements of these rules rely in part on FMV in financial dealings. Not all valuations are created equal. Hospital and physician practice executives and their health care attorneys should rigorously qualify the valuators they engage. Moreover, knowing where the valuation firm stands on controversial issues such as the workforce/asset approach issue is an important part of the vetting process.
As Bradford and Tuomey demonstrated, indefensible valuations of health care contractual arrangements can contribute to tremendous risk to the parties. Similarly, casual knowledge of the health care industry by valuation analysts, such as its regulatory environment, and misapplication of valuation theory and techniques, can likewise subject those relying on the outside or internal valuation analyses to substantial risk.
We welcome the spotlight on workforce valuation and the technical resource the paper provides. Unfortunately, the debate on workforce valuation lingers on.
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