On July 2, 2007, the Centers for Medicare & Medicaid Services (CMS) issued a proposed rule that would revise payment rates and a number of policies under the Medicare Physician Fee Schedule (“Proposed Rule”). CMS stated that “this proposed rule is a further step in Medicare’s efforts to ensure that payment policies provide incentives to improve the quality of care.” CMS indicated that it will accept comments until August 31, 2007, and will publish a final rule later in the Fall. The final rule is scheduled to be effective for services provided on or after January 1, 2008. In addition to revising physician payment rates, the Proposed Rule also contains a number of proposed changes to the Stark Regulations governing physician self-referrals. As CMS put it, the Proposed Rule contains provisions “modifying a number of physician self-referral provisions to close loopholes that may have made the Medicare program vulnerable to abuse.”

Among those proposed revisions to the Stark Regulations are new provisions that would have a major impact on physician relationships with hospitals and other providers, including provisions concerning purchased diagnostic tests, in-office ancillary services, unit-of-service (“per-click”) payments in space and equipment leases, percentage-based compensation arrangements, and services furnished by physicians to another provider “under arrangements.”

Purchased Diagnostic Tests

CMS is proposing to change the regulations relating to purchased diagnostic tests, to impose an anti-markup requirement on both the technical and professional components, where the tests are billed by a medical group or physician but performed by an outside supplier. The only exception would be where tests are performed by a full-time employee of the billing entity.

In-Office Ancillary Services Exception

There is a lengthy discussion of the in-office ancillary services exception (IOAS), indicating that CMS is concerned about potential abuse in this area. The agency notes that services are provided under the IOAS exception in a manner that extends beyond what was originally intended under the Stark Regulations. It notes that “pathology services may be furnished in a building that is not physically close to any of the group practice’s other offices, and the professional component of the pathology services may be furnished by contractor pathologists who have virtually no relationship with the group practice (in some cases, the technical component of the pathology services is furnished by laboratory technologists who are employed by an entity unrelated to the group practice).”

CMS states that it is concerned with these arrangements, but is not making a specific proposal for amending the IOAS exception. Rather, it is soliciting comments on whether changes are necessary and if so, what those changes should be. It specifically requests comments on the following:

  • Whether certain services should not qualify for the exception (for example, among other things, “complex laboratory services”)
  • Whether changes should be made to the definition of “same building” or“centralized building”
  • Whether non-specialist physicians should be able to use the exception to refer patients for specialized services involving the use of equipment owned by the non-specialists
  • Any other restrictions that might curtail abuse.

Unit-of Service (“Per-Click”) Rental Payments

The Stark Law provides an exception to the prohibition on physician referrals for space and equipment leases that meet certain requirements. Among those requirements are that the lease be commercially reasonable even if no referrals are made between the parties, and that the rental charges be set in advance, be consistent with market value, and not be determined in a manner that takes into account the volume or value of referrals between the parties. In the Stark II Regulations, CMS permitted time-based or unit-of-service-based payments even where the physician receiving the payment generated that payment through a referral, so long as the payment per unit was at fair market value at the inception of the lease and did not subsequently change in a manner that takes into account referrals for designated health services. In the new Proposed Rule, CMS is proposing to eliminate the provision that has permitted unit-of-service-based payments to a physician lessor for services rendered by an entity lessee to patients who are referred by that physician. In proposing this change, CMS stated:

[W]e believe that such arrangements are inherently susceptible to abuse because the physician lessor has an incentive to profit from referring a higher volume of patients to

the lessee, and we would disallow such per-click payments…even if the statute does not expressly forbid per-click payments to a lessor for patients referred to the lessee.

CMS also indicated that it is soliciting comments on whether it should prohibit per-click payments to a lessor by a physician lessee to the extent that those payments reflect services rendered to patients referred by the physician lessee.

Percentage-Based Compensation Arrangements

Several of the Stark Law exceptions require that compensation be “set in advance.” In the Stark II Regulations, CMS clarified that if a specific compensation formula is used, that formula must be set forth in sufficient detail before the furnishing of items or services and the formula may not be modified within the time period of the agreement in any manner that reflects the volume or value of referrals between the parties. Now, CMS has indicated its concern that percentage compensation arrangements have been used for the provision of services or items other than physician services, such as equipment and office space, on the basis of a percentage of the revenues derived from such equipment or office space. CMS indicates in the Proposed Rule its concern that percentage compensation arrangements in the context of equipment and office space rentals are potentially abusive. As a result, CMS proposes to clarify that percentage compensation arrangements:

(1) May be used only for paying for personally-performed physician services; and

(2) Must be based on the revenues directly resulting from the physician services, rather than based on some other factor, such as a percentage of the savings by a hospital department (which is not directly or indirectly related to the physician services provided).

This change would appear to affect arrangements, such as management services agreements, where a physician might be paid a percentage of revenues of a facility, where those revenues potentially could include payments for the use of equipment or office space.

Services Furnished “Under Arrangements”

Under the current Stark Regulations, the referral prohibition applies to a physician who has a financial relationship with the “entity” furnishing a designated health service (DHS). CMS defined the “entity” furnishing a DHS to be the entity billing and receiving payment from Medicare. In addition, the Stark Regulations provide that an “under arrangements” contract between a hospital and an entity owned by one or more physicians does not constitute an ownership interest by the physicians in the hospital. Thus, currently, a physician who owns an interest in an entity providing a DHS “under arrangements” to a hospital is not subject to a prohibition on referring patients to the hospital for that service if the “under arrangements” contract is structured properly.

In the Proposed Rule, CMS is proposing to revise the definition of “entity” in the Stark Regulations so that a DHS entity includes both the person or entity that performs the DHS, as well as the entity that submits claims to Medicare for the DHS. In offering this proposed change, CMS stated the following:

[W]e continue to have concerns with services provided under arrangements to hospitals and other providers. We believe that the risk of overutilization that we identified in the 1998 proposed rule has continued, particularly with hospital outpatient services for which Medicare pays on a per service basis. . . . We have received anecdotal reports of hospital and physician joint ventures that provide hospital imaging services formerly provided by the hospital directly. There appears to be no legitimate reason for these arranged for services other than to allow referring physicians an opportunity to make money on referrals for separately payable services. Many of the services furnished by the joint venture were previously furnished directly by the hospitals, and in most cases, could continue to be furnished directly by the hospitals.

In addition, CMS expressed concern that services furnished under arrangements to a hospital often are furnished in a less medically-intensive setting than the hospital, but nonetheless are billed at higher outpatient hospital PPS rates. CMS went on to say:

[I]t appears that the use of these arrangements may be little more than a method to share hospital revenues with referring physicians in spite of unnecessary costs to the program and to beneficiaries.

If the proposed change in the definition of DHS entity were implemented, the ability of a physician to refer patients for a DHS to a hospital where the physician owns an interest in the entity providing the DHS “under arrangements” would be curtailed.


The changes to the Stark Regulations contained in the Proposed Rule would have far-reaching consequences for physician relationships with hospitals and other providers. Eliminating the acceptability of “per-click” rental arrangements in equipment or space rental agreements, together with prohibiting percentage compensation arrangements in many arrangements, would mean that physician-owned entities would not be able to structure space or equipment leases or services contracts in a manner consistent with widely accepted industry practices. Likewise, the extension of the Stark Law prohibition to physician-owned entities providing DHS “under arrangements” to a hospital would make it very difficult, if not impossible, for a physician to own an interest in a joint venture with a hospital or to pursue other “partnering” arrangements with a hospital pursuant to the “under arrangements” model.