The proposed Medicare physician fee schedule (PFS) regulations released on July 2, 2007, include provisions that will affect the entire health care industry, not just physicians and other providers paid under the fee schedule. The proposed rule includes a nearly 10 percent decrease in Medicare physician fee schedule payments, which when coupled with proposed relative value unit (RVU) changes and changes required by statute would result in decreases of from 6 percent to 12 percent across physician specialties other than anesthesiology, which would receive an increase. The proposed rule also addresses a variety of other fee schedule related matters, including the Physician Quality Reporting Initiative (PQRI); Comprehensive Outpatient Rehabilitation Facility (CORF) regulations; requirements for Physical Therapy, Occupational Therapy, and Speech-Language Pathology services; Part B drug payment; and clinical laboratory fee schedule, including provisions for incorporating new tests. The Centers for Medicare and Medicaid Services (CMS) is also using this PFS rulemaking as a vehicle for revisions to the Stark Law regulations and certain rules regarding reassignment and purchased services, Independent Diagnostic Testing Facilities (IDTFs), and services “under arrangements,” which individually, and in combination, would limit the options for structuring arrangements for many health care services and require restructuring many existing arrangements that comply with current law. This white paper summarizes the proposals affecting permissible arrangements for health care services and the effect of the proposed regulations on common arrangements across the United States.

Physician Self-Referral (Stark Law) Issues

The CMS press release issued with the proposed rule states that the proposed Stark Law revisions are intended “to close loopholes that have made the Medicare program vulnerable to abuse.” The proposed changes, combined with CMS’ requests for comments on certain additional issues (without specific proposed language) and foreshadowing of the “Phase III” regulations reflect an intent to significantly narrow the scope of certain exceptions and would adversely affect a number of common arrangements that currently comply with the law based on the indirect compensation exception, the in-office ancillary services exception, and the definition of a designated health services (DHS) “entity” for Stark Law purposes.


In the proposed 2007 Medicare Physician Fee Schedule Update, CMS expressed concerns about so-called pathology pod labs— pathology laboratory “in-sourcing” arrangements between pathology laboratories and physician practices involving the shared use of equipment, technologists and interpreting pathologists. These arrangements, which enable gastroenterology, urology and other high utilizers of pathology services to bring pathology services in-house, have been possible because of the Stark in-office ancillary services exception (the “In-Office Exception”) and the contractual arrangement exception to the general prohibition on reassignment of Medicare benefits (the “Contractual Exception”). CMS believes that these types of diagnostic testing arrangements between medical practices or between diagnostic test suppliers and medical practices are an abuse of these two exceptions. After considering a variety of approaches to addressing its concerns, CMS is proposing to prohibit physicians and medical practices from marking up to the Medicare program the outside supplier’s net charge to the practice for the diagnostic testing, i.e. the outside supplier’s charge net of any payment by the outsider supplier for use of the medical practice’s facility. Notably, this anti-markup rule applies regardless of whether the diagnostic test is purchased from the outside supplier or the medical practice is billing Medicare in reliance on a reassignment from the outside supplier performing the diagnostic test pursuant to a contracted services arrangement (i.e., the Contractual Exception). The only exception to the rule is reassignment from a full-time employee of the medical practice. CMS did not propose amendments to the In-Office Exception, most notably the definition of “centralized building,” believing that its anti-markup approach will sufficiently address its concerns.

However, CMS recognizes that contractual arrangements between medical practices and technologists (and, by implication, contractual arrangements between medical practices and diagnostic testing equipment lessors or suppliers) involve neither the purchase of the technical component of a diagnostic test nor billing by the medical practice in reliance on a reassignment of benefits from the technologist (or equipment lessor or supplier). Consequently, CMS’ anti-markup rule will not apply to the technical component of diagnostic testing billed by medical practices pursuant to pathology pod lab or similar diagnostic testing arrangements (in reliance on the In-Office Exception, and, in particular, the definition of “centralized building”). CMS requests comments on the notion of an anti-markup rule that would apply to any diagnostic test billed by a medical practice in reliance on the In-Office Exception’s “centralized building” approach. This approach would result in the closure of numerous group practice DHS sites operating currently in reliance on the “centralized building” approach, and that have nothing to do with pathology pod labs or other in-sourcing arrangements that are the target of CMS’ concerns. Presumably, CMS will receive many comments challenging such an approach.

The net effect of CMS’ proposed rule, if adopted, will be to eliminate any economic incentive for a medical practice to bill Medicare for the professional component (interpretation) of a diagnostic test not performed by a full-time employee of the practice. Notably, the medical practice will not even be able to recover from Medicare the overhead practice expense of interpretations performed in the practice’s facilities by part-time or independent contractor physicians, while such on-site interpreting physicians will be able to separately bill and receive Medicare payment that reflects such overhead expense, using the medical practice’s office as the site of service, i.e. non-facility practice expense RVUs. Consequently, if the proposed rule is adopted, medical practices with arrangements for on-site interpretations by part-time or independent contractor physicians may elect to stop billing Medicare for such interpretations (since there is no incremental margin on such interpretations) and, instead, charge the interpreting physician for use of the practices’ facilities, a cost to the interpreting physician for which he or she can be reimbursed by Medicare (through the non-facility practice expense RVUs).


CMS proposes to clarify that in any appeal of a denial of payment based on the Stark Law prohibition, the burden of proof is on the entity submitting the claim that the service was not furnished pursuant to a prohibited referral. In practice, this generally means that the burden is on the provider to prove every element of a Stark exception. CMS’ position is consistent with the weight of cases that have examined the question of burden of proof in connection with False Claims Act actions predicated on an alleged Stark violation. The burden on the provider is a particular challenge when invoking the regulatory exceptions, which typically require that the arrangement not violate the federal anti-kickback law.


The in-office ancillary services exception is the key exception that permits physicians to furnish DHS in their medical practices. CMS states that Congress’ original intent underlying the exception was “to allow for the provision of certain services necessary to the diagnosis or treatment of the medical condition that brought the patient to the physician’s office,” and expresses concern that the exception currently permits arrangements that “appear to be nothing more than enterprises established for the self-referral of DHS.” CMS is particularly concerned about arrangements that are not “closely connected” to the physician practice, and singles out arrangements where nonspecialists use the exception to bill for specialized services; physical and occupational therapy services; and “turn-key” in-office laboratory and imaging operations “being marketed to physicians over the internet.” CMS is not proposing any specific changes at this time, but rather solicits comments on whether the in-office ancillary services exception should be narrowed to address CMS’ concerns.


The regulations currently permit payments on a per service basis (often referred to as “per click” payments) for personal services, as well as space and equipment leases, so long as the payment per unit is at fair market value and does not change during the term of the arrangement in a manner that takes into account DHS referrals. Accordingly, a physician may lease a piece of equipment to a hospital on a per click basis, even if the physician refers patients to the hospital for services using the equipment. CMS has now determined that “such arrangements are inherently susceptible to abuse,” and accordingly has proposed to narrow the exceptions for space and equipment leases (but not for services) so that per click payments would not be permitted “to the extent that such charges reflect services provided to patients referred by the lessor to the lessee.” As currently drafted, the narrowing of the exceptions would apply only if an individual physician was the lessor, and would not currently apply to per click arrangements where the physician owns an entity that in turn has a per click relationship with a hospital. Such arrangements would still be subject to an indirect compensation analysis rather than a lease exception analysis. However, as noted below, CMS has also indicated that it is likely that an upcoming rule (possibly Phase III of the Stark Law regulations) may provide that a physician stands in the shoes of his/her practice entity and possibly other entities, which would significantly broaden the scope of the proposed change—and further narrow the protection of the indirect compensation exception. CMS also is soliciting comments on whether a parallel prohibition on per click payments should be imposed where the physician is the lessee (e.g., where a physician leases a piece of equipment on a per click basis from a hospital).


The preamble states that as a starting point CMS believes that the period of payment disallowance resulting from a Stark Law violation should “begin with the date that a financial arrangement failed to comply with the statute and the regulations and end with the date that the arrangement came into compliance or ended.” CMS also believes that in some instances it may not be clear when a financial arrangement has ended and that some prohibited financial arrangements might be intended to affect referrals even after the legal arrangement has ended (e.g., below market rent was in exchange for future referrals, including referrals made beyond the expiration of the lease). While not proposing any new regulatory interpretation at this time, CMS is seeking comments regarding when the prohibition should end in particular situations. CMS is also seeking comments about whether there should be a mechanism for early termination of the prohibition in cases in which the parties have “returned, or paid back the value of, the improper consideration and neither knew nor should have known that an arrangement failed to satisfy the requirements for an exception.” CMS is also considering whether it should disqualify parties from using an exception for some additional period where an arrangement has failed to satisfy the applicable requirements. The preamble discussion does not indicate how broadly such a disqualification would be applied. For example, would failure to satisfy the conditions for an exception in an individual case disqualify the provider from relying on that exception in all other cases or only regarding the particular arrangement that has previously failed to satisfy the requirements?


Several of the compensation exceptions require that compensation be “set in advance,” including the space and equipment lease exceptions, the personal service arrangement exception, the fair market value exception and the academic medical center exception. The current Stark rules provide that percentage compensation arrangements are “set in advance” so long as the percentage is fixed. CMS now proposes that only percentage arrangements based on revenues directly resulting from physician services and used to pay for personally performed physician services are “set in advance.” This would have the effect of, among other things, prohibiting percentage leases (even where unrelated to DHS) that have relied on the lease exceptions for protection. Perhaps of equal importance, in the past some have argued that percentage arrangements that include DHS do not “take into account” DHS. CMS’ increasingly restrictive view of percentage arrangements may cast doubt on that position.


CMS proposes that where a DHS entity owns or controls an entity to which a physician refers Medicare DHS, the subsidiary would be collapsed into the parent for purposes of the Stark analysis. This would have the effect of converting some current indirect compensation arrangements into direct ones, necessitating the use of the direct exceptions. CMS also indicates that it may treat physicians as standing in the shoes of their group practices or other physician practices (it is unclear whether this would apply to all group members or just to owners). Again, this could have the effect of limiting the number of arrangements protected by the indirect compensation exception and necessitating that more arrangements be structured to meet a direct exception. Coupled with the proposed restrictions on percentage arrangements, the “stand in the shoes” proposals, if finalized, would require the restructuring of many existing hospital-physician joint ventures and lease and management arrangements, even where the compensation is fair market value and does not vary based on DHS referrals.


In response to comments on the Phase II regulations suggesting that CMS should exercise its discretion regarding minor and technical violations and failure to meet the procedural requirements of an exception (e.g., failing to obtain all required signatures prior to commencement of the agreement), CMS is considering whether to provide for an alternative method for satisfying certain exceptions. An alternative method, if adopted, would be applicable only in cases of “inadvertent violations in which an agreement fails to satisfy the procedural [or ] ‘form’ requirements of an exception,” but would not be available with respect to fair market value, not related to volume or value of referrals, or set in advance issues. CMS proposes to limit the availability of the alternative method to cases in which:

  • there has been a self-disclosure to CMS;
  • the arrangement satisfied all but the prescribed procedural or “form” requirements at the time of the referrals and the claims;
  • failure to meet all the prescribed requirements was inadvertent;
  • the referrals and the claims were not made with knowledge (or reckless disregard) that the prescribed criteria were not met;
  • the arrangement did not pose a risk of program or patient abuse;
  • no more than a set amount of time has passed since the original noncompliance;
  • the arrangement is not the subject of any ongoing federal investigation or other proceeding;
  • the parties have brought (or will bring as soon as possible) the arrangement into complete compliance with the prescribed criteria of the exception or have terminated (or will terminate as soon as possible) the financial relationship between or among them.

(According to CMS, this item was inadvertently left out of the rule as originally published, but will be added to the version to be published in the Federal Register. The comment period for this section will be extended to September 7, 2007.) Furthermore, the applicability of the alternative method in a particular case would be in the sole discretion of CMS, and the parties would not have any procedural or appeal rights regarding its determinations. As currently contemplated, the proposal appears too restrictive and subject to interpretation to be useful in practice. CMS is seeking comments on all aspects of the proposal, including time lines and standards of documentary proof for the proposed determinations.


Under current Stark regulations, an entity is not considered the entity that furnishes Stark’s designated health services (the “DHS Entity”) unless it is the entity that is paid by Medicare for the DHS. Consequently, investment by a physician in an entity that supplies, leases or otherwise furnishes services or items to, a DHS Entity that the physician makes referrals to for DHS (the “Intermediary Entity”) is not considered ownership or investment by the physician in a DHS Entity, because the Intermediary Entity is not paid by Medicare for the DHS. This is the case even if the physician-owned Intermediary Entity furnishes or performs the DHS “under arrangements” with a hospital paid by Medicare for the DHS, e.g., imaging services or radiation therapy services furnished directly to registered outpatients of a hospital pursuant to a contractual arrangement between the Intermediary Entity and the hospital. Since an Intermediary Entity is not considered a DHS Entity under current regulations, investment by a physician in an Intermediary Entity does not have to qualify for one of the Stark ownership/investment exceptions (only one of which, the rural investment exception, would potentially apply to such investment). Instead, physician investment in an Intermediary Entity currently implicates Stark because it generally creates an indirect compensation arrangement between the physician investor and the DHS Entity that contracts with the Intermediary Entity. However, there is a special indirect compensation exception that hospitals and other DHS Entities contracting with physician-owned Intermediary Entities have often relied on as a basis for proceeding with such transactions.

In the proposed rule, CMS expresses concerns about “under arrangements” transactions between hospitals and physician-owned Intermediary Entities that appear to be designed solely to enable the physician-investors to profit from referrals to the hospital, and/or in the case of ambulatory surgery and imaging services, for example, enable the hospital to receive the higher providerbased Medicare payment even though the service is furnished in a less medically intensive setting, e.g., ambulatory surgery center or independent diagnostic testing facility. In addition, CMS concurs with the concern expressed by MedPAC, in its March, 2005 Report to Congress, that physician ownership of entities that provide services and equipment to imaging centers and other providers creates inappropriate financial incentives. MedPAC recommended that CMS “should expand the definition of physician ownership in the physician self-referral law to include interests in an entity that derives a substantial portion of its revenue from a provider of designated health services” (the “MedPAC Approach”). CMS shares MedPAC’s concern, and has requested comments on the MedPAC Approach, but did not propose to adopt the MedPAC Approach. The proposed rule provides that the DHS Entity is either the entity that submits a claim to Medicare for the DHS, or the entity that performed the DHS (the “CMS Approach”). The CMS Approach, for which no “grandfathering” is proposed, would, if adopted, require either:

  • divestiture of physician investors in Intermediary Entities that perform DHS, i.e. furnish the DHS to the DHS Entities’ patients;
  • termination of the contractual arrangements between such Intermediary Entities and DHS Entities; or
  • the cessation of Medicare billing by the DHS Entity for the DHS furnished by the Intermediary Entity.

For example, mobile or fixed site PET scan, nuclear stress testing and radiation therapy services arrangements between a hospital and an independent, physician-owned provider of these DHS to the hospital’s patients would have to be terminated or the associated Medicare billing stopped unless the referring physicians are divested.

However, many contractual arrangements between physician-owned Intermediary Entities and DHS Entities, such as hospitals, do not call for the Intermediary Entity to perform DHS. Rather, the Intermediary Entity furnishes to the DHS Entity one or more of the “inputs” utilized by the DHS Entity in the performance of DHS, e.g. space, management services, staff, medical equipment and/or medical supplies. Depending on the precise facts and circumstances, certain of these “inputs” might, separately or taken together, arguably constitute a DHS. For example, implantable devices might constitute a “hospital service” if implanted in a hospitalized Medicare beneficiary, and if so construed, surgeon investment in a wholesaler of implantable devices (the Intermediary Entity) would be substantially restricted by the Stark Law. However, most of the “inputs” furnished to a DHS Entity by a physician-owned Intermediary Entity, even when viewed in their totality, cannot reasonably be viewed as a DHS performed by the Intermediary Entity. For example, the lease of a technologist and a high-resolution CT scanner to a hospital by a physician-owned Intermediary Entity would not appear to constitute the performance of a hospital service, as “hospital services” are defined by the Stark regulations. Consequently, even though the CMS Approach will certainly disrupt many existing arrangements between physician-owned Intermediary Entities and DHS Entities, the extent of this disruption may depend on the outcome of CMS’ request for comments on whether it should adopt the MedPAC Approach, either in combination with the CMS Approach, or as a substitute for the CMS Approach.

The MedPAC Approach would apparently put an end to physician investment in any entity that derives a substantial portion of its revenue from the provision of services or items to a DHS Entity, regardless of whether the provision of such services or items constitutes the performance of DHS. If not accompanied by a “grandfathering” provision, CMS’ adoption of the MedPAC Approach would cause the unwind of hundreds of contractual arrangements between physician-owned Intermediary Entities and DHS Entities, many of which the parties involved would argue are well-intentioned, commercially reasonable, pro-competitive and likely to improve the quality and lower the cost of health care in their markets. These arguments will likely be the subject of many comments on the proposed rule.

Independent Diagnostic Testing Facility (IDTF) Issues

Closely related to the general theme of the revisions proposed in connection with the Stark Law, the proposed updates also provide for some significant revisions and clarifications to existing IDTF performance standards and propose several new IDTF performance standards, including one standard that could dramatically impact block leasing and other shared imaging arrangements. The proposed updates, if adopted, will surely create new challenges for IDTFs which are still feeling the impact of reimbursement cuts under the Deficit Reduction Act, the recently imposed multiple procedure discount as well as the reforms to some of the IDTF standards recently enacted by CMS on January 1, 2007. Interestingly, some of the proposed updates, including the controversial ban on shared arrangements, address matters that CMS attempted to address in CMS Transmittal 187 issued in late January 2007. CMS, however, ultimately rescinded such transmittal due to the controversy and questions elicited from the imaging industry. Below is a summary of some of the more significant changes being proposed.


CMS proposes revising the liability insurance standard to clarify that an IDTF must carry liability insurance of not less than three hundred thousand ($300,000) dollars in coverage per incident. The current standard does not use the phrase “per incident;” however, since many IDTFs already carry such insurance coverage, we do not anticipate this change having a substantial impact on the imaging industry. Of greater controversy is CMS’ proposal that an IDTF be required to notify its CMS designated contractor of any policy changes or cancellations and add such CMS designated contractor as a certificate holder on the insurance policy. Moreover, failure to maintain the required insurance will result in revocation of the IDTF’s billing privileges retroactive to the date the insurance lapsed. Insurance companies may be reluctant to name a government agency as a certificate holder, as that could provide a basis for the government to seek indemnification or payment that it would not otherwise have under the policy. Additionally, IDTFs would be subject to a rather draconian penalty (no reimbursement for services rendered) even in the instance of a mere technical lapse in insurance coverage.


Currently, an IDTF must report any change of information required to be disclosed in its CMS Form 855-B application within 30 days after the effective date of the change, regardless of the materiality of the change. CMS proposes revising the § 410.33(g)(2) standard to require that any change in ownership, location, general supervision, or adverse legal actions must be reported within 30 calendar days of the change and all other changes must be reported within 90 days. This proposal will likely be welcomed by the imaging industry as it should reduce some of the administrative burdens that IDTFs currently face in making timely reporting disclosures to CMS.


CMS proposes changing the standard in § 410.33(g)(8) to require IDTFs to “answer, document, and maintain documentation of beneficiaries’ questions and responses to their complaints at the physical site of the IDTF.” This change also requires an IDTF to document its complaint process.


In the final 2007 MPFS rule, it appeared that CMS unintentionally expanded the scope of responsibilities of the physician responsible for providing general supervision for the IDTF by requiring such supervising physician to be responsible for the overall administration of the IDTF and compliance with applicable regulations. In response to negative industry feedback, CMS has proposed deleting such requirement. A physician currently cannot provide general supervision to more than three IDTF sites. The proposed updates clarify that this prohibition includes both fixed and mobile units where three concurrent operations are capable of performing tests.


CMS also proposes a new standard that provides that an IDTF cannot retroactively bill for any services rendered before the IDTF submitted a Medicare enrollment application that is complete and can be processed by CMS for approval. While this new standard will not preclude an IDTF from retroactively billing, it does limit the period in which an IDTF can do so. An IDTF must also be more cautious to submit a thorough and complete application prior to providing any services or risk not receiving any reimbursement for such services.


CMS also proposes a new standard that would prohibit an IDTF from sharing space, equipment, or staff, or from subleasing its operations to another individual or organization. CMS indicates that the purpose of this new standard is intended to better enable CMS to confirm that an IDTF is operating in compliance with the Medicare conditions of participation. CMS also notes in the proposed updates that shared arrangements raise concerns under the physician self referral prohibition (i.e., Stark law) and the federal anti-kickback statute. If this standard is adopted, it will likely have a significant impact on the shape of the imaging industry. The proposed standard, however, leaves many questions unanswered and will likely solicit significant public comment. For example, will this standard apply to an IDTF wholly owned by a physician practice? CMS had previously carved out such physician-owned IDTFs from a similar restriction that it published in Transmittal 187, which ultimately was rescinded. Moreover, as we had mentioned in the On the Subject issued in February of 2007, will the space sharing prohibition be interpreted consistent with other Medicare rules prohibiting concurrent use of a Medicare certified facility (such as in the ambulatory surgical center setting)? Because the proposed standard uses the phrase “sublease,” it suggests that will not be the case. If the sublease provision is retained, then material restructuring will likely be required for many arrangements. If the final standard does not prohibit the sublease of operations, then block leasing and other shared arrangements where a participant’s use can be easily distinguished from another’s use, may not be materially affected.

The medical imaging industry was successful in having CMS Transmittal 187 rescinded. It will be interesting to see the imaging industry’s reaction to this latest affront on IDTFs. Those already engaged in shared imaging arrangements should have them reviewed, while those contemplating entering into these types of arrangements will need to structure them in a manner that complies with the new standards or otherwise have them unwound.


While one’s position in the health care marketplace may affect one’s reaction to these proposals, there is no question that CMS’ proposals to close perceived “loopholes” will also significantly limit providers’ flexibility in structuring viable and compliant arrangements for health care services in their communities and their ability to respond creatively to the inevitably evolving economic and regulatory environment. Based on the preamble to the proposed regulations, it is not clear that CMS has considered all of the implications and potential effects of these proposals, individually, collectively or in conjunction with other existing rules and interpretations. This white paper discusses many , but certainly not all, of the implications of these proposals.

We recommend that all health care organizations consider the potential impact of these proposals on their arrangements and operations and determine what arrangements would need to be revised to comply with provisions of the proposed rule. We also encourage affected organizations to participate in the policy making regarding these important rules by submitting comments to CMS by the August 31, 2007 regulatory deadline.