Jason RuchaberThe Affordable Care Act set in motion myriad changes to the healthcare industry, including a fundamental shift in the perception of health care. The current system is designed to provide what some refer to as “sick care,” with insurance policies, patient behaviors, treatment protocols, and reimbursement all designed to coincide with the onset and subsequent treatment of illness or injury.

The concept of health care is being redefined to focus on the triple aim of enhancing the overall health of populations, improving the patient experience, and reducing the per capita cost of care. Despite significant disagreement and uncertainty as to how to accomplish these objectives, the most likely path will be some variation of value-based medicine.

The Center for Value Based Medicine defines the concept as “the practice of medicine based upon the objective value (improvement in length of life and/or quality of life) conferred by healthcare interventions as determined by utilizing a set of standardized parameters commonly used to evaluate value and cost-effectiveness.” Practically speaking, value-based medicine requires aligning payment mechanisms to incentivize prevention, high-quality care, and treatment protocols with the best outcomes relative to their cost. This approach also entails a migration from our fee-for-service model into one or more value-based models—e.g., shared savings, pay-for-outcomes, pay-for-quality.

The shift away from fee-for-service is a monumental task that likely will take many years to accomplish while meeting with fierce opposition from those who benefit under the current model. But even with the path yet to be defined, the industry is mobilizing resources and investing massive amounts of capital to prepare for the new future of health care. As a business appraiser, I have witnessed how consolidation has evolved from the acquisition of physician practices to the purchase of ambulatory services and entire hospitals, not to mention mega-system mergers such as Tenet’s acquisition of Vanguard and Community Health Systems’ purchase of Health Management Associates. I have been directly involved in many of these deals, but as the industry continues to evolve I can’t help but wonder if we are adequately accounting for these changes in our valuation models.

What Is Fair-Market Value?

In the healthcare industry, deals generally must be priced at fair-market value (FMV), as defined in the Stark Law. Numerous resources discuss the nuances of complying with this definition of FMV, so I don’t need to get into detail here. It is important to note, however, that FMV precludes consideration of buyer-specific synergies, and appraisers generally avoid making significant alterations to the existing revenue and cost structure of the business when building their forecasts and valuation models.

Moreover, appraisers typically use historical performance as a basis for these models, extrapolating the past as a means to project the future. In our fee-for-service world, this approach entails modeling some volume metrics—e.g., relative value units, procedures, and scans—then applying reimbursement rates based on either existing levels plus inflation or guidance from the Medicare Patient Advisory Commission, and modeling variable costs in a similar manner.

How can this approach determine the fair-market value of a business when the future likely will look nothing like the past? More important, how does valuing a healthcare business in this way adequately differentiate high-quality and lower-quality practices?

These are not easy questions, and finding answers is made more difficult by issues such as constant legislative posturing, undefined quality metrics, and uncertain future payment mechanisms. Despite these challenges, business appraisers must rethink many of the quantitative and qualitative elements of the appraisal process in accordance with the realities of the industry. Finding consensus on anything related to health care is difficult, of course, but we need constructive dialogue to evolve our processes and stay relevant in this rapidly changing industry.

Five Keys to Future Healthcare Valuations

The following five considerations will be key in future healthcare evaluations.

The past is not indicative of the future. The use of a discounted cash-flow model that extrapolates the past may not result in an accurate valuation. Projected financials developed under a premise of fee-for-service likely do not reflect the economic realities of the healthcare industry. Valuation models should consider the various forms future reimbursement models may take and whether these models will result in a gain or loss of revenue and profits.

Higher quality should equal higher value. High quality does not always translate into high profit or high value—or vice versa—under fee-for-service. Taking more time with patients, preventing subsequent visits or additional tests, avoiding surgical intervention when nonsurgical treatment is available—these behaviors all result in lower revenue and lower profits in the current environment. From a financial viewpoint, the current system also may result in the highest-quality practices receiving the lowest valuations. Higher quality should result in higher value, particularly with the shift to value-based medicine.

But how do we measure quality? Unfortunately the metrics are not defined, and comparative data is limited. Still, appraisers should seek to assimilate new data into their valuation process as it becomes available. In the meantime, appraisers should work with administrators and medical directors to understand the various quality initiatives that are in place and develop risk scoring that can adjust valuation discount rates to reflect indicators of quality. Cash-flow forecasts also should reflect incentive payments and cost-savings initiatives with probability adjustments based on the likelihood of realization.

IT matters. The use of big data finally has made its way into health care. The HITECH Act, passed in 2009, helped facilitate the start of this transition, which I expect to result in significant advances in clinical care and population health. Healthcare companies that have started to incorporate IT into their practices are better-positioned to succeed in this new era. As with high-quality clinical practices, however, the investment and initial inefficiency caused by technology implementation may lead to the incorrect conclusion that the business is worth less.

Implementing IT infrastructure and processes is expensive, and may lead to lengthy periods of suppressed cash flow. However, appraisers need to incorporate adjustments to reflect future returns on this investment and, conversely, recognize that practices that have not started the process face significant capital-investment and competitive disadvantages.

Capital expenditures matter, too. High-quality care, better outcomes, and improved patient experiences cannot happen with antiquated equipment and facilities. The uncertainty and declining reimbursement faced by industry participants have led many businesses to delay or avoid necessary capital expenditures. This problem reinforces the need to conduct onsite inspections as part of business appraisals, and further highlights the role quality should play in the valuation process. Valuations of businesses that have not invested adequately in capital equipment should make note of likely cash-flow reductions and an increase in the discount rate.

Pricing transparency could lead to culture change. The Centers for Medicare & Medicaid Services recently released pricing data for the 100 most common inpatient services, 30 most common outpatient services, and all procedures and services that have been performed by physicians and other providers on at least 11 Medicare beneficiaries. Many hospitals and health systems voluntarily are releasing similar pricing data or making efforts to do so. As patients become more responsible for the cost of their care in the wake of increasing deductibles and coinsurance rates, and as providers release data regarding the prices of their services, we may see the advent of healthcare consumerism.

This dynamic could fundamentally change patient behaviors and preferences, and solidify the importance of quality in health care. Businesses that historically have flourished because of higher prices or more favorable payer contracts may find that patients no longer see the value associated with their facility. Conversely, those with the highest-quality outcomes and highest patient preference may see demand, and prices, start to rise. In this context, appraisers should employ a more comprehensive benchmarking of both prices and outcomes while recognizing that historical payer leverage may fade as the consumer becomes more informed and empowered.

In conclusion, although the term “value” means different things to different people, appraisers should actively seek ways to attribute financial value to the businesses and behaviors that are most likely to bring positive and lasting change to our industry.


Jason Ruchaber, CFA, ASA, is the founder and managing partner of Root Valuation, a healthcare-focused business valuation and financial advisory firm, a member of the Healthcare Special Interest Group subcommittee of the American Society of Appraisers, and a member of HFMA’s Colorado Chapter.

Publication Date: Friday, June 13, 2014