Accountable Care Organizations – Is the IRS Impeding Needed Health Reform?

In a fee for service payment system, a medical service
provider generally is paid based upon how many tasks or procedures are performed.  This system contributes to fragmented care by
the various healthcare providers serving a patient, often resulting in duplications
of effort and the provision of unnecessary care.  For example, a primary care doctor may order
a laboratory test for a patient on the initial encounter. If this patient requires
admission to a hospital or treatment by a specialist, the same test could be
reordered, perhaps several times, a costly and inefficient process.

Recently, several federal initiatives have been announced
that attempt to realign incentives to hospitals, physicians and other
healthcare vendors to coordinate patient care. 
The Medicare Shared Savings Program (“MSSP”) is one such effort.  MSSP is essentially a three year voluntary
program that is intended to begin the shift from a volume based payment model
to a value or quality based model.  It is
designed to pay Medicare providers on a fee for service basis, but to allow the
sharing of Medicare cost savings with these providers.  To participate in the MSSP, the providers
must be members or owners in an Accountable Care Organization (“ACO”).  Under the program, the ACO will receive a
portion of the cost savings generated (if any) to the Medicare program assuming
certain quality benchmarks are satisfied. 
The ACO will be responsible for the distribution of the cost savings to the
various ACO participants.  The goals of
MSSP are to provide better care for Medicare beneficiaries, better health for
the Medicare population and lower growth in program costs. 

To function properly, an ACO must have access to sufficient
capital to invest in the necessary infrastructure that allows the coordination
of patient care, including significant investments in clinical and
administrative information systems and other enabling technologies.  The capital investment required to operate an
ACO is substantial.  Under current
guidance, ACO participants (hospitals, physicians, suppliers) must control the
organization. Physician participation is absolutely essential in order to
achieve the hoped for cost savings and coordination of patient care.  However, independent physicians are unlikely
to have the funds needed to invest proportionately in an ACO relative to other
providers. Tax-exempt hospitals are prohibited from subsidizing the investment
of a private party. 

In order to facilitate the formation of an ACO, general tax
and valuation principles allow a tiered capital structure. For example, an ACO
could issue preferred stock to certain participants and voting common stock to
all participants.  The preferred stock
would possess economic rights, such as distribution and liquidation
preferences, that support a more substantial capital investment relative to the
investment in common stock.  Physicians
would invest in common voting stock (as would all other ACO participants).  Unfortunately, IRS guidance in this area is
not sufficiently clear to come to this conclusion when tax-exempt hospitals are

In order to allow the formation of ACOs and their operation
consistent with the intent of the MSSP, the IRS should clarify that the use of
tiered capital is acceptable if supported by proper valuation principles.
Otherwise, the capital investment required to operate an ACO will prevent many
physicians (and small tax-exempt hospitals) from participating. The MSSP is an
interesting Medicare experiment that could help move Medicare from the volume
based payment system that most everyone recognizes is broken.  However, if physicians cannot afford to
participate, the experiment will fail.

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