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The Stark II Phase II Interim Final Rule

Client Alert | 19 min read | 04.06.04

On March 26, 2004, the Department of Health and Human Services ("HHS"), through the Centers for Medicare and Medicaid Services ("CMS"), issued an Interim Final Rule (69 FR 16054), further implementing the physician self referral, or Stark Law, found at 42 U.S.C. § 1395nn. In promulgating the Phase II Rule, CMS articulates its goal of attempting to "reduce the burden and prescriptive nature of the rule while applying the statute and maintaining the integrity of the regulatory framework." Indeed, while remaining true to the Stark Law's requirements, the approach of CMS in promulgating the Phase II Rule is refreshing and helpful. In contrast to CMS' regulatory approach to interpreting the Stark Law in 1998, the Phase II Rule establishes broader, more realistic exceptions, while narrowing the Stark Law's coverage. We summarize the Interim Final Rule below.

The summary is organized according to the following Table of Contents. You can click on a topic and then go directly to that discussion:

TABLE OF CONTENTS
I. OVERVIEW
 A. Important Modifications to Existing Exceptions
 B. New Exceptions
 C. Important Interpretations of Key Definitions and Concepts
 D. Technical Changes to DHS Definitions
 E. Relaxation of Reporting Requirements
 F. Left Undone: Non-Risk Based Medicaid Referrals
II. ANALYSIS OF KEY COMPONENTS OF THE PHASE II RULE
 A. Important Modifications to Existing Exceptions
  1. Compensation Arrangement Exceptions
   a. Unification of Criteria Related to "Core" Physician Compensation Arrangements
   b. Employment Relationships
   c. Personal Service Arrangements
   d. Physician Recruitment
   e. Indirect Compensation Arrangements
   f. Rental of Space and Equipment
   g. Isolated Transactions
   h. Services Furnished by Managed Care Organizations to Enrollees
   i. Risk-Sharing Arrangements
   j. Non-Monetary Compensation and Incidental Benefits to Medical Staff
   k. Compliance Training
   l. Special Rules on Compensation
  2. Modifications to General Exceptions
   a. Academic Medical Centers
   b. Group Practice Definition/In-Office Ancillary Services Exception
  3. Modification to Ownership/Investment Interest Exceptions
   a. Publicly-Traded Securities
   b. Rural Providers
   c. Moratorium on Specialty Hospital Ownership
 B. New Exceptions
  1. Professional Courtesy
  2. Retention Payments for Physicians in Underserved Areas
  3. Certain Arrangements in Temporary Noncompliance
  4. Establishment of Community-Wide Health Information Systems
  5. Intra-Family Rural Referrals
  6. Charitable Donations by Physicians to DHS Entities
 C. Important Interpretations of Key Definitions and Concepts
  1. Referral
  2. Consultation
  3. Fair Market Value
  4. Volume or Value of Referrals
  5. Set in Advance
 D. Changes To DHS Definitions
  1. Physical Therapy Services
  2. Occupational Therapy Services
  3. Radiology and Certain Other Imaging Services
  4. Radiation Therapy Services and Supplies
  5. Durable Medical Equipment (DME) and Supplies
  6. Parenteral and Enteral Nutrients, Equipment and Supplies
  7. Prosthetics, Orthotics, and Prosthetic Devices and Supplies
  8. Home Health Services
  9. Outpatient Prescription Drugs
  10. Inpatient and Outpatient Hospital Services
 E. Reporting Requirements



On March 26, 2004, the Department of Health and Human Services ("HHS"), through the Centers for Medicare and Medicaid Services ("CMS"), issued an Interim Final Rule (69 FR 16054), further implementing the physician self referral, or Stark Law, found at 42 U.S.C. § 1395nn. The Stark Law prohibits a physician from making referrals for the furnishing of certain "designated health services" ("DHS") for which payment may be made under the Medicare or Medicaid programs, if the physician or a member of a physician's immediate family has a financial relationship with a health care entity, unless an exception applies.

The Preamble informs that the Interim Final Rule is Phase II ("Phase II Rule") of a "bifurcated" final rulemaking process. Proposed regulations were first published in 1998 (63 FR 1659). Phase I regulations were published in 2001 (66 FR 856) and, with two exceptions, became effective on January 4, 2003.1 Although CMS intended to address referrals for Medicaid-covered services in this rulemaking, it has almost completely postponed Medicaid issues until a later date2.

In promulgating the Phase II Rule, CMS articulates its goal of attempting to "reduce the burden and prescriptive nature of the rule while applying the statute and maintaining the integrity of the regulatory framework." Indeed, while remaining true to the Stark Law's requirements, the approach of CMS in promulgating the Phase II Rule is refreshing and helpful. In contrast to CMS' regulatory approach to interpreting the Stark Law in 1998, the Phase II Rule establishes broader, more realistic exceptions, while narrowing the Stark Law's coverage. Where "bright line" standards assist in articulating excepted relationships, such standards are often established; in instances where more flexibility in interpretation or definition would be helpful, CMS has demonstrated a willingness to adjust its approach in that direction. In the end, while physician ownership in designated health service entities remains largely impermissible, virtually every physician compensation arrangement with a DHS entity will be protected if the compensation involved is fair market value, and does not vary based on the volume or value of referrals.


1) Regulations pertaining to home health services became effective on April 6, 2001, and the effective date of the final sentence of § 411.354(d)(1), relating to the definition of "set in advance" has been delayed four times.
2 ) This rulemaking does, however, amend the pre-paid plans exception at § 411.355(c) to include Medicaid managed care plans.


A. Important Modifications to Existing Exceptions

In addition to the establishment of important new exceptions, Phase II provides mostly helpful revisions to a number of existing exceptions and criteria relating to them. Importantly, the rule serves to standardize – to the extent permitted by the statute – the criteria applicable to "core" physician compensation arrangement exceptions (e.g., the employment, personal services, academic medical center, and fair market value exceptions), by refining key definitions relating to these exceptions, including the "fair market value," "set in advance," and "volume or value of referrals" terminology. In addition, important modifications were undertaken relating to the following:

Compensation Arrangement Exceptions
 1. Physician recruitment
 2. Indirect compensation arrangements
 3. Rental of office space and equipment
 4. Medicaid managed care relationships
 5. Risk-sharing arrangements
 6. Non-monetary compensation and incidental benefits
 7. Isolated transactions
General Exceptions
 1. Academic medical centers
 2. Group practice / in-office ancillary services
Ownership / Investment Interest Exceptions
 1. Publicly – traded securities
 2. Rural providers
 3. Specialty hospital ownership moratorium.


B. New Exceptions


The Phase II Rule also establishes a series of new exceptions related to:

  • Professional courtesy
  • Retention payments for physicians in underserved areas
  • Community-wide health information systems
  • Intra-family rural referrals
  • Charitable donations by physicians to DHS entities
  • Certain arrangements involving temporary non-compliance

C. Important Interpretations of Key Definitions and Concepts

In crafting a Rule intended to expand opportunities to avoid Stark Law violations and narrow the statute's coverage, CMS also adjusted its interpretations of a number of concepts essential to the Law's exceptions. Revisions in interpretation and/or definition were made to the following key definitions:

  • referral / consultation
  • "set in advance" compensation
  • fair market value
  • volume or value of referrals
  • hospital services

D. Technical Changes to DHS Definitions


No new DHS has been added to those covered by the Stark Law, nor has any DHS category been deleted. CMS has clarified further the coverage of DHS in general, and made specific technical changes in a number of DHS categories.


E. Relaxation of Reporting Requirements

The Phase II Rule provides significant relief with respect to the reporting requirements initially set forth in the Stark Law. CMS has determined that annual or periodic reporting of Stark-related information by DHS entities would, in effect, be a costly waste of time. Relieving this burden on both itself and DHS entities, CMS has decided to impose no formal reporting obligation. Indeed, DHS entities will simply be required to maintain records in accordance with other applicable laws and normal business practices, and provide relevant documents to CMS or the OIG upon request.

F. Left Undone: Non-Risk Based Medicaid Referrals

CMS continues to grapple with how – or whether – the Stark Law will cover the dwindling number of non-risk based Medicaid referrals. The agency has once again deferred this issue, instead expanding applicable risk-based exceptions to cover Medicaid risk-based programs.



II. ANALYSIS OF KEY COMPONENTS OF THE PHASE II RULE

A. IMPORTANT MODIFICATIONS TO EXISTING EXCEPTIONS

1. Compensation Arrangement Exceptions

a. Unification of Criteria Related to "Core" Physician Compensation Arrangements

The Stark Law provides varying criteria for meeting the statutory exceptions for "core" physician compensation arrangements based on the status of the physician, i.e. whether the physician is a DHS entity employee or independent contractor, involved in a group practice, part of an academic medical center, etc. CMS itself has advanced these incongruities through oral interpretation.

In the Phase II Rule, however, responding to commentary questioning the rationality of these various criteria, CMS has sought to "equalize" the requirements for these core physician compensation exceptions. In doing so, CMS points out the "statutory preference" conferred upon group practices, and concludes that the advantages available to group practice physicians cannot, by rule, be provided to others. As regards physicians involved in the other "core" physician compensation arrangements exceptions, however – employment, personal services, fair market value, and academic medical centers – all physicians can now be paid:

    • a percentage of revenues or collections for services personally performed
    • productivity bonuses for services personally performed
    • based upon participation in a duly-constituted "physician incentive plan."

With regard to physicians practicing in group practices, additional compensation flexibility remains. Group practice members:

    • can share in-office ancillary service revenues, or profits of the group based in part on DHS revenues, provided the allocation method is not based "directly" on individual physician referrals.
    • can enjoy productivity bonuses not only for services personally performed but for "incident to" services as well.
    • need not be compensated at "fair market value" nor have their compensation "set in advance" (note : employed physicians are also not required to meet the "set in advance" requirement).

We address below how the "core compensation" exceptions related to employment and personal services arrangement have been modified in the Phase II Rule to accommodate these interests by unifying criteria and in other ways. Thereafter, other key modifications to existing exceptions are addressed.

b.  Employment Relationships

Although on its face the employment exception to the Stark rules regarding compensation arrangements technically remains unchanged, the Phase II Rule offers new interpretations in applying this exception. Specifically, CMS declined to adopt a controversial provision of the 1998 proposed rule which would have excluded from the exception productivity bonuses based on a physician's own referrals of DHS, even when personally performed. The proposed rule would have also added a restriction on compensation related to "other business generated" between the physician and the DHS entity. Both of these proposed changes were dropped from the Phase II Rule's version of the exception.

In addition, CMS has adopted a definition of "employee" that tracks the common law definition in the statute. CMS specifically declined to adopt a definition that would incorporate state law definitions of employment. Finally, CMS has endorsed certain specific payment methods as permissible under the exception. These include compensation based on a flat fee for each mid-level provider supervised by the employed physician and payments based on quality measures (so long as, in each case, such compensation represents fair market value and does not take into account referrals).

c.  Personal Service Arrangements

In the Phase II Rule, CMS has modified the personal service arrangements exception in an attempt to ease compliance with the exception's requirements. While further modification would have been helpful, the revised exception represents a step in the right direction.

Most importantly, a significant amendment has been made to the regulatory definition of "fair market value" set forth in 42 C.F.R. § 411.351 as it pertains to personal service arrangements. Specifically, CMS has created two alternative "safe harbor" methodologies that may be used to calculate hourly payments for physician's personal services ( i.e. , services performed by the physician personally, and not by employees, contractors, etc.), which calculations will result in compensation levels "deemed" to be fair market value.

Under the first methodology, fair market value is satisfied if the hourly rate is less than or equal to the average hourly rate for emergency room physician services in the relevant physician market, provided there are at least three hospitals providing emergency room services in the market. The flaw in this approach appears to simply be the difficulties inherent in obtaining these data, as well as the risks in relying on the compensation levels of competitors in establishing payment rates.

As an alternative, fair market value is also deemed to exist if the hourly rate is determined by averaging the 50th percentile national compensation level for physicians within the same physician specialty (or, if the specialty is not identified in the survey, for general practice) in at least four of the six surveys specifically identified in the regulation, and dividing by 2,000 hours. The regulation identifies the six survey sources as: Sullivan, Cotter & Associates, Inc; the Hay Group; Hospital and Healthcare Compensation Services; Medical Group Management Association; ECS Watson Wyatt; and William M. Mercer.

CMS emphasizes that compliance with these "safe harbor" methodologies is "entirely voluntary" and that entities may continue to establish fair market value through other methods. Practically speaking, however, one can assume that these methodologies quickly may become the standard in the industry for hourly rate calculations. As a result, providers should familiarize themselves now with one or both alternatives.

In other modifications, as with the office space and equipment lease exceptions (discussed supra ), the personal service arrangements exception now explicitly permits termination with or without cause during the first year of the agreement. In order to qualify for this exception, however, the parties may not enter into the same (or substantially the same) arrangement during the first year of the original term of the arrangement being terminated.

CMS has also attempted to ease the "separate arrangements" approach first proposed in 1998. Under the Phase II Rule, a physician (or family members) may have multiple arrangements with an entity so long as either (a) the arrangements incorporate each other by reference, or (b) each arrangement cross-references a master list of contracts that is maintained and updated centrally and is available for review by the Secretary of HHS upon request. This master list is expected to identify historical as well as current agreements between the parties. There can be several master lists that are cross-referenced, or the DHS entity may even rely upon "annual or other regular financial statements (such as quarterly statements) that clearly show the parties, dates, payments, and purposes of payments separate for each personal service contract" so long as such statements are appropriately cross-referenced in the agreement. Thus, while the new revisions should ease some burdens of contract drafting, maintaining a master list will require consistent and careful administrative attention.

CMS also indicates in Phase II Rule comments, that it has reconsidered its interpretation that items and equipment cannot be included in an arrangement under the personal service arrangements exception. CMS notes, however, that it will separate services and equipment contained in a single arrangement for purposes of determining fair market value.

The Phase II Rule also clarifies that a physician or family member need not personally perform the services for which the entity has contracted. Rather, such services may be "furnished" through employees, through a wholly owned entity, or through locum tenens physicians. Notably, the exception does not apply to a situation in which a physician (or family member) has hired an independent contractor to perform the services for which the physician (or family member) has contracted.

d.  Physician Recruitment

The Phase II Rule substantially modifies the physician recruitment exception in several respects, all of which are likely to be embraced by providers. Key modifications include the new focus of the exception on the relocation of the physician's medical practice rather than the physician's residence. As modified, a physician is deemed to have "relocated" his or her medical practice if the site of the practice is moved at least 25 miles, or at least 75% of the physician's revenues from services provided to patients (including inpatients) are derived from services provided to "new" patients (patients not seen by the physician in his or her previous practice for at least three years). For the initial "start up" year of the physician's relocated practice, the revenue test is "whether it is ‘reasonable to expect' that the recruited physician will meet the 75% test."

Another important modification in the Phase II Rule allows for the recruitment of residents and physicians who have been in practice for less than one year, even if the physician or resident does not relocate. In CMS's view, these physicians do not have an established practice to relocate. The recruited physician must establish his or her practice in the hospital' s geographic area to be eligible for recruitment payments under the exception.

The Phase II Rule also ends the debate over whether the recruitment exception, or any other exception, protects payments made by a hospital to a group practice (or to a physician) when the recruited physician joins a group practice upon relocation. Indeed, the Preamble reflects CMS's recognition that there are legitimate reasons why recruited physicians prefer to join existing practices. Payments to group practices are now explicitly protected under the Phase II Rule, provided certain criteria are met. Specifically a) the agreement must be set forth in writing and signed by all parties; b) remuneration must be passed directly through to the recruited physician (except for actual costs incurred by the practice in recruiting the new physician); c) in the case of an income guarantee, the costs allocated by the practice to the recruited physician cannot exceed the actual incremental costs to the practice attributable to the physician; d) the physician must be allowed to establish staff privileges at any other hospital and, finally, e) the physician practice receiving the hospital payments may not impose additional practice restrictions on the physician (i.e., a non-compete agreement) beyond those related to quality considerations.

Finally, the Phase II rule expands the recruitment exception to cover federally qualified health centers ("FQHCs") that recruit physicians to join their medical staffs. This extension was granted in an effort to ensure that the statute "does not impede efforts by FQHCs, which provide substantial services to underserved populations, to recruit adequate staff." CMS refused to grant similar extensions to other DHS providers such as home health agencies and nursing homes, citing concerns that recruitment arrangements at such facilities could pose a risk of abuse. (See also, discussion of the new "Retention" exception at Section II.B.2. below).

e. Indirect Compensation Arrangements

In the Phase I Rule, CMS recognized that under the terms of the Stark Law, indirect compensation arrangements could implicate the statute's coverage. In order to address this issue at that time, CMS both defined what comprised an "indirect compensation arrangement" and established an exception for such relationships. Significant confusion resulted from what appeared to be CMS' creation of an unnecessarily complex process for first identifying and then excepting these indirect relationships. Some commenters suggested to CMS that such arrangements could simply be analyzed under existing available exceptions, e.g. if one of the relationships in a chain met an exception, no further analysis was necessary. In the Phase II Rule, however, CMS has held its ground on the analytical need to both establish the indirect compensation arrangement definition and an analog exception. CMS expressed concern that parties might attempt to shield a compensation arrangement that was ultimately improper via an intermediary relationship that was excepted. The Phase II Rule does, however, provide some additional clarification as to how these arrangements are defined and excepted.

It is axiomatic that resort to the indirect compensation exception is required only in the event that an indirect compensation arrangement exists in the first place. Such a relationship occurs only if:

  • there is an unbroken chain of financial relationships between the DHS entity and the referring physician (through ownership/investment interest or compensation arrangement);
  • the aggregate compensation received by the referring physician varies based on the volume or value of referrals; and
  • the DHS entity has actual knowledge of that relationship (or acts with deliberate ignorance or reckless disregard of its existence).

Importantly, the Phase II Rule makes clear that the DHS entity has no duty to inquire as to the presence of such a relationship. Thus, in arrangements with group practices, for example, DHS entities must determine whether or not to inquire beyond the direct compensation relationship as to how that group practice intends to split its revenues among its physicians. Whether a contractual representation/warranty should be sought that the group practice will not allocate compensation to its owner/employee physicians based on the volume or value of referrals is unclear. In any event, there is no requirement

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