Apr 1998 Table of Contents

Physician Practice Management Companies: Too Good to Be True?

More family physicians are joining forces with the likes of PhyCor and MedPartners. Find out what PPMCs have to offer.

Fam Pract Manag. 1998 Apr;5(4):44-56.

Like the endgame in a chess match, the drive toward consolidation in the health care industry is forcing physicians to make choices with momentous consequences. With health plans, hospitals and pharmaceutical companies joining forces, it seems that only physician organizations big enough to sit at the table will have access to managed care contracts. Most experts believe that only physician organizations with deep pockets, economies of scale, high-priced management expertise and sophisticated information networks will have what it takes to negotiate those contracts.

If the experts are right, the question for physicians is no longer whether to consolidate, but with whom and at what cost. Throughout the country, solo practitioners, group practices and even clinics of several hundred physicians are looking for partners with the necessary capital and organizational expertise and experience to help them innovate and grow. Choosing such a partner could be the most important move physicians will ever make, for themselves and for their patients.

Right now, physicians have two major options for gaining the scale, structure and resources to stay competitive. One is to expand independently and acquire other practices in the market. Even with inspired leadership, capital and business savvy, this is a tall order.

The other option is to sell to a bigger group, health plan, hospital or physician practice management company (PPMC). While selling your practice may take care of your short-term concerns about survival, it introduces a whole new set of potential concerns, including loss of autonomy and a new set of uncertainties about long-term stability. Yet practice sales are up, and one type of buyer in particular seems to be thriving. In 10 years, PPMCs have evolved into a multibillion-dollar industry. (See the list of the largest publicly traded PPMCs on page 49.)

The 10 largest publicly traded PPMCs

Of the roughly 35 publicly owned and 250 privately owned PPMCs, a disproportionate number are located in the South. MedPartners, the largest PPMC by far, is headquartered in Birmingham, Ala. The second largest, PhyCor, is based in Nashville, Tenn. Atlanta is also a hotbed of PPMC activity, but Texas may have more PPMCs than any other state.

Michael Parshall, vice president of The Health Care Group, a health care consulting firm with offices in Plymouth Meeting, Pa., and Greenville, S.C., theorizes that cities in the South are fertile ground for PPMCs because they are relatively early-stage managed care markets with growing populations.

The following list is limited to publicly traded companies because exact data on privately owned PPMCs can be difficult to obtain and verify; the companies are ranked by the number of affiliated physicians.

PPMC Headquarters Type of company Date of public offering Number of affiliated physicians*

MedPartners

Birmingham, Ala.

multispecialty

1995

5,865

PhyCor

Nashville, Tenn.

multispecialty

1992

3,860

FPA Medical Management

San Diego

primary care

1994

2,134

PHP Healthcare Corp.

Reston, Va.

primary care

1991

500

Physicians Resource Group

Houston

ophthalmology

1995

431

PhyMatrix Corp.

West Palm Beach, Fla.

multispecialty

1996

372

ProMedCo Management Co.

Fort Worth, Texas

primary care

1997

359

Physician Reliance Network

Dallas

oncology

1994

326

American Oncology Resources

Houston

oncology

1995

311

Advanced Health Corp.

Tarrytown, N.Y.

multispecialty

1996

280


*This figure represents the number of full-time physician employees of practices acquired by the PPMC. It does not include physicians in IPAs with which the PPMC has a managed services contract.

PPMC Headquarters Type of company Date of public offering Number of affiliated physicians*

MedPartners

Birmingham, Ala.

multispecialty

1995

5,865

PhyCor

Nashville, Tenn.

multispecialty

1992

3,860

FPA Medical Management

San Diego

primary care

1994

2,134

PHP Healthcare Corp.

Reston, Va.

primary care

1991

500

Physicians Resource Group

Houston

ophthalmology

1995

431

PhyMatrix Corp.

West Palm Beach, Fla.

multispecialty

1996

372

ProMedCo Management Co.

Fort Worth, Texas

primary care

1997

359

Physician Reliance Network

Dallas

oncology

1994

326

American Oncology Resources

Houston

oncology

1995

311

Advanced Health Corp.

Tarrytown, N.Y.

multispecialty

1996

280


*This figure represents the number of full-time physician employees of practices acquired by the PPMC. It does not include physicians in IPAs with which the PPMC has a managed services contract.

Source: Sherlock Company, Gwynedd, Pa., publisher of PPMC, a monthly newsletter that provides financial analysis of publicly traded PPMCs. Information supplied on March 9, 1998.

The differences between PPMCs and MSOs

A decade ago, many people had difficulty figuring out exactly what the infant PPMC industry was all about. Management service organization (MSO) was the generic term both for physician-owned MSOs and startup PPMCs like PhyCor, which was founded in 1988. Today, with scores of privately and publicly owned PPMCs, the distinction between the two types of management entities is much clearer.

Most PPMCs specialize in working with primary care physicians, single-specialty groups, hospital-based physicians or multispecialty groups. The bulk of the revenue of primary care and multispecialty PPMCs is generated from acquired group practices and the balance from management services contracts with independent practice associations (IPAs).

The primary role of a PPMC is to be a strategic partner for physicians. “Very few groups have the corporate skills or discipline to create a capital structure that allows them to invest in their future growth,” says Tom Dent, PhyCor executive vice president, chief operating officer and one of the founders of the Nashville, Tenn.-based company. “Some of that is because their capital and financing structure tends to be based upon each physician's personal financial strength as opposed to bringing the strength of a corporate partner to bear in that area.” Most practices also lack an adequate management infrastructure, skilled leadership and managed care expertise, according to Dent. These are things a PPMC can bring to a group in what Dent describes as “a very, very competitive world.”

Stephen George, MD, MBA, a family physician who is founder, chairman and chief executive officer of Atlanta-based First Physician Care, concurs: “PPMCs can provide physicians with very focused and effective resources in terms of management expertise, capital, information systems and best practices both on the business and clinical sides from an intelligent enterprise with experience across the country.” A PPMC can also bring economies of scale, according to George, when it comes to employee benefits, purchasing, malpractice insurance and recruiting key personnel and physicians.

An MSO, on the other hand, which may be owned by physicians, one or more hospitals, an IPA or an HMO, handles practice administration, management and contracting functions. Practices may also benefit from economies of scale by consolidating operations and purchasing through their MSO. Theoretically, an MSO can perform many of the same functions as a PPMC. The problem is that physicians typically regard their MSOs as overhead and have tended not to fund them beyond the bare necessities, thereby limiting the effectiveness of most MSOs.

Health Partners Medical Group of Forth Worth, Texas, is a case in point. When the group grew to 60 primary care physicians in 1995, with prospects for more than double that number, family physician and medical director Michael Jutras, MD, says they realized that their MSO would need help with capital and infrastructure. After talking with venture capitalists, investment bankers and PPMCs, the group affiliated with First Physician Care, a privately owned PPMC oriented toward primary care, in 1996.

“Basically, we had a small PPMC with our MSO,” says Jutras. “But to be successful in this market, you need continued access to capital, sophisticated information systems and management expertise, and the last two things you get with the first. We also felt a national company was the way to go because you're more valuable if you're part of an organization with locations in different markets.”

Jutras adds that investing in their own practices is one of the toughest concepts to get across to physicians. “At the end of the year, they flush everything out and don't reinvest back in the business,” he says. “Then they wonder why the HMOs and hospitals are so strong, and why they don't have the systems to be successful. That's why our group was very prepared to become part of a PPMC.”

How affiliation works

When PPMCs count their affiliated physicians, they include both the physicians in IPAs with which they have management service contracts and the physicians in the practices that they've purchased. Both types of relationship have significant effects on affiliated practices.

Management services. In an IPA management services model, a PPMC provides management services and negotiates managed care contracts in return for a negotiated fee. Management services agreements between PPMCs and IPAs generally last from seven to 15 years.

Joel Victor, MD, a solo family physician, practices in Hawthorne, N.J. He is a member of Primary Care Physicians of New Jersey, a 100-physician IPA that signed a management services agreement with FPA Medical Management in late 1994. The IPA is looking to the San Diego-based, primary-care-oriented PPMC for help in consolidating the administrative burden that comes with managed care contracts and in negotiating higher reimbursement rates with health plans.

“I think the biggest benefit is going to be the consolidation of back-office staff work and more control of the health care dollars,” says Victor, whose practice is about 60 percent managed care. The advantage for the IPA physicians is that they'll be dealing solely with FPA Medical Management instead of numerous individual plans for preauthorizations, referrals and formularies.

In a market with numerous solo practices and small groups, the PPMC itself may start an IPA as an intermediate step to forming one or more group practices it can later acquire. A PPMC with one or more affiliated groups in a market may organize other practices in an IPA “wrap-around” strategy to strengthen its competitive position.

“If the managed care company has 40 percent of your patients, then you cannot leave the negotiating table without a deal,” explains Geoffrey Anders, JD, president and chief executive officer of The Health Care Group, a health care consulting firm with offices in Plymouth Meeting, Pa., and Greenville, S.C. “On the other hand, if a group has 40 percent of the managed care company's subscribers in the area, then the managed care company cannot leave the table without a deal.”

Practice acquisition. In the practice acquisition or equity model, the PPMC buys the tangible and intangible non-real-estate assets of the group for a lump-sum payment of cash, PPMC stock or a combination of the two. Selling a practice to a PPMC can boost a physician's net worth in the short term (see “What PPMCs will pay”). But the real benefits of a successful affiliation with a PPMC, such as management of risk-based contracts, better patient care, a growing practice and increasing physician compensation, are more likely to accrue over the long-term relationship. Physicians who give undue weight to the lump-sum payments for their practices may end up with a bigger check but not necessarily a better deal if the PPMC they choose to affiliate with doesn't have much to offer beyond a great sales pitch and a marginally better purchase offer.

What PPMCs will pay

How much a PPMC will pay for a medical practice depends on the PPMC, the practice, local market conditions and a variety of other factors. Practice valuation can be calculated as a multiple of annual practice revenues or of earnings before interest and taxes.

The most common valuation method for smaller practices and groups is to multiply the PPMC management fee by a factor of five or six, according to Michael Parshall, vice president of The Health Care Group, a health care consulting firm. For example, suppose a group practice generates annual gross revenues of $2 million and operates at 50 percent overhead, and the PPMC's fee is 15 percent of the $1 million profit (also referred to as the precompensation margin or predistribution pool of funds), or $150,000. Using a factor of five, the PPMC may offer $750,000 to buy the practice.

Typically, the practice purchase price includes the tangible and intangible non-real-estate assets. The intangible component, usually referred to as good will, is the difference between the purchase price and the tangible assets.

Selling your practice to a PPMC for a lump-sum payment consisting of stock, cash or a combination of the two can generate a substantial windfall in your personal finances. The potential tax consequences of that transaction may also be to your advantage.

“Let's say you're paying 30 percent in taxes on the ordinary income from your practice,” Parshall explains. “If you sell your practice to a PPMC, the proceeds are taxed as a capital gain at a lower rate. So by capitalizing part of your compensation from your practice, you end up paying less in taxes on the same amount of money.”

Physicians in the affiliating group practice sign employment agreements with a professional corporation (PC) that is created for this purpose. Nonphysician personnel become employees of the PPMC's local subsidiary. The employment contract with the PC typically includes restrictive covenants that make it difficult for the physician to terminate the agreement. This is intended to ensure a stable group that will grow in physician members and revenue over time.

Physicians elect their own board of directors to run the PC and make decisions about clinical care. Business decisions for the affiliated group practice are made by a joint policy board. This body typically consists of three physicians and three nonphysicians, such as the practice's executive director and two PPMC representatives, one specializing in operations and one in finance.

For a percentage of the group's profits, called the predistribution pool of funds or precompensation margin, the PPMC agrees to provide the group with a variety of resources, such as capital, management expertise, strategic planning, access to managed care contracts and an information infrastructure. PPMC management fees range from 15 percent to 20 percent of practice profits.

The term of the contract between the group practice and the PPMC can range from 20 to 40 years. At the end of this time, there may be provisions for renewal of the arrangement or for reversion of the business entities and non-physician employees back to the practice, with assets being bought or leased back. Exactly what happens when the contract expires or if the parties decide to “unwind” their agreement earlier is described in the agreement.

The importance of practice growth

The promise of equity affiliation with a PPMC is that the infusion of know-how and capital will lower practice costs and increase practice revenues. To make up for its percentage of the practice profits, the PPMC must also generate practice growth, often referred to as “same-store growth.” Until practice growth raises profits enough to cover the PPMC's management fee, every dollar that goes to pay for the PPMC's management fee comes out of physician compensation — and out of new-physician compensation, which is why a newly affiliated practice may have trouble recruiting new members.

Exactly how a PPMC-affiliated practice generates same-store growth depends on the PPMC, the practice and the local market. Theoretically, the affiliated group and the PPMC both have a financial interest in generating practice growth. PPMCs point to this alignment of incentives as an important feature of the equity model. But actually generating significant same-store growth requires a high degree of collaboration between a practice and a PPMC with commitment, capital and high-caliber talent in operations, management, financing and strategic planning.

In the real world, a PPMC that acquires a lot of practices may not necessarily have what it takes to make those practices grow and succeed in the long run. All PPMCs are in business to make money, and a PPMC can show years of healthy profits before it becomes apparent that it is either unable or unwilling to generate growth in its affiliated group practices. And if the PPMC or its affiliated practice runs into trouble, drastic measures, such as cutting physician compensation or worse, may be unavoidable.

“A real concern I have is that a lot of these organizations are founded by investors who will take them public, take some cash out of the transaction and leave the physicians with an organization that may or may not succeed in the future,” says Nathan Kaufman, senior vice president of Superior Consultant Co. Inc., The Kaufman Group Division, in San Diego. “We've seen PPMCs actually go bankrupt before they've been able to go public.”

Equity affiliation with a PPMC also can make for strange bedfellows if your PPMC merges or is acquired. The acquiring PPMC may be one you turned down when you were shopping around, or you may end up consolidating operations with your local competitors if you end up affiliated with the same PPMC.

Loss of autonomy

Nobody makes any bones about the fact that physicians lose some autonomy when they affiliate with a PPMC. But most affiliated physicians seem willing to give up some control over the business side of the practice for what they're getting in return.

“Prior to our arriving, physicians would have had 100 percent of the votes on issues of policy and strategy, and in most locations they will give some of that up to PhyCor,” says Dent. “But the physicians look to us to provide certain advice and expertise, and I seldom, if ever, hear physician groups with which we're affiliated saying, ‘We feel like you've intruded on our decision making.’”

When FPA Medical Management bought family physician Jeoffry Gordon's solo practice in 1994 and hired new employees, he expected to feel some resentment after 15 years in private practice. But Gordon admits that FPA's handling of the situation met his most optimistic expectations. He also points out that unaffiliated physicians who contract with managed care organizations routinely give up autonomy in areas such as specialty consults, treatment facilities and drug formularies.

Primary care physicians contemplating affiliation with a multispecialty PPMC may have concerns about autonomy of another kind. Ken Davis, MD, one of six family physicians in Conroe Family Practice in Conroe, Texas, admits that he worried about the possibility of being viewed as a “second-class citizen” by specialists in the Sadler Clinic, a PhyCor affiliate he and his colleagues joined in 1992. Instead, he says primary care and family practice physicians are “driving the bus.”

Jutras says he and most of his colleagues see the loss of day-to-day responsibility for running their practices as a good thing. When it comes to clinical autonomy, he says what many affiliated physicians say: “PPMCs don't get involved in clinical decisions.”

“I find that PPMCs will shy away from decisions regarding practice-of-medicine issues,” says Kaufman. “But if pharmacy capitation pools are being utilized and physicians are not prescribing from the formulary, then clearly the PPMC is going to bring that to the physicians' attention.”

The notion that PPMCs don't want to get involved in clinical decisions may be wishful thinking when it affects the bottom line, especially as competition for managed care contracts intensifies. According to Dent, clinical performance is exactly what PPMCs are gearing up to compete on.

“The physician who's thinking about the future has to recognize that managing care, whether it's capitated or not, is going to be essential,” says Dent. “Without physician behavior modification, you don't get maximum clinical performance within a network, and we think the time is coming when physicians will be rewarded for getting the best clinical results.”

Whether Dent's vision of the future becomes reality depends on physicians, on employers, on government-funded programs and ultimately on what consumers demand from their health plans. But it seems likely that the current concept of clinical autonomy will evolve and that PPMCs will play a role in that evolution.

“From a theoretical standpoint, the PPMC platform does provide a forum for doctors to exchange ideas, something that is often lacking in private practice,” says Anders. “It's also very clear that practice management companies exercise input in the area of clinical improvement. How much influence the PPMC can exercise in compelling change is still in question.”

The odds of success

Unfortunately, not all PPMCs are created equal. The right PPMC can offer you and your practice tremendous resources. Selling to the wrong PPMC, however, could cost you a chunk of your current income and potentially your entire practice. So if you're considering affiliation with a PPMC, the trick is to pick the right one.

When a practice affiliates with the right PPMC, the results can be impressive. Conroe Family Practice is a case in point. “We're up to about 40 percent capitation,” says Davis. “We're doing Medicare risk and commercial risk, which we would have never considered doing on our own, and we're doing risk with hospitals. We also have in-house physical therapy, lab, radiology and nuclear medicine, and these ancillary services generate income that we didn't have before.”

But not all practices fare this well.

“We find that about a third of physicians who have gone with a PPMC feel that they're better off because they did,” says Kaufman. “A third feel like it's pretty much a wash, and another third find that compensation is down, they're having difficulty recruiting new members into the group and they wish they'd never made the move.”

Most PPMCs have more expertise in raising and investing money than in running medical practices, in the opinion of Michael Parshall, vice president of The Health Care Group. “It is unrealistic to expect a PPMC to help consolidate a bunch of doctors and magically have this wonderful management infrastructure imposed upon these practices,” says Par-shall, who specializes in PPMCs. “Most PPMCs aren't going to do much more than what the doctors can do on their own. Physicians still need to have a very good idea about what it is they want to do, how to develop the strategy and how to implement that strategy in their local markets.”

George makes the same point from his perspective as both a family physician and a leader of a PPMC. In essence, he advises physicians to focus on their internal vision, mission and values, and to figure out where they are headed and what is required to get there before starting discussions with PPMCs.

If you decide that affiliation with a PPMC could be the right move for your practice, you should weigh your options carefully, gathering as much information as possible about key indicators such as the PPMC's corporate philosophy and values, management qualifications and track record in similar markets with similar practices. In short, you will need to do everything you can to increase your odds for a successful partnership with a PPMC.

Bob Carlson is a health care writer based in Indianapolis.

 

Editor's note: In an upcoming issue, independent consultants, PPMC executives and affiliated family physicians will offer advice about what to do when a PPMC comes calling, how to evaluate PPMCs and how to maximize the chances of a successful relationship with a PPMC.

 

Copyright © 1998 by the American Academy of Family Physicians.
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