The small northern Texas town of Greenville always seemed to its physicians like a refuge from most of the world's problems. The winds were more likely to blow the scent of the flowering bluebells than the ill news of encroaching managed care. Still, as far back as 1987, the six forward-thinking physicians of the two family practices in town had begun to feel the pinch of rising costs. And when the insurers of the town's primary industries began to offer capitation contracts, they knew they had to do something to better their positions. So, William Cantrell, MD, Howard Kweller, MD, and James Nicholson, MD, of the Medical and Surgical Clinic and Robert Dewell, MD, Pete Gray, MD, and Dee McCrary, MD, of the Longbranch Family Practice Clinic joined forces in 1992 to form the professional corporation Family Practice Associates (FPA).

The first issues they addressed were call sharing, fee-schedule development, joint purchasing and personnel sharing. This arrangement was a positive move, but not the complete answer. “Joining the two groups was a good beginning, but it was just a finger in the dike,” recalls Gray.

A winning strategy

At Cantrell's urging, FPA engaged May and Associates, a professional management firm based in Richland, Mo., to help the two practices become certified as rural health clinics (RHCs). (For more information on rural health clinics, see “Would Your Practice Do Better as a Certified Rural Health Clinic?” Family Practice Management, November/December 1995, page 58.) This status enabled the practices to employ midlevel providers. This broadened their practices, increased patient volume and generated higher revenues. Medicare and Medicaid reimbursement rose from less than $25 to $50 per visit as a RHC. With the help of their RHC consultant, the physicians also took steps to improve the efficiency of their practices. According to Cantrell, this led to a reduction in overhead from 65 percent to 50 percent.

While the physicians saw more money from Medicare and Medicaid patients, they still had concerns about capitation. They lacked the expertise and experience to effectively negotiate managed care contracts and, as a result, they were unable to achieve a satisfactory capitation rate. They also worried that more personnel would be needed to handle the growing administrative hassles associated with managed care, such as tracking referrals. “We just don't have the time to deal with these things and take care of our patients too,” says Nicholson.

About this time, two large hospitals from outside the area offered to purchase and manage their practices, but the offers proposed no real improvements in their situations. The physicians feared they would end up with less control over their practices. “We knew we had to have somebody's help, but we didn't want to lose our autonomy entirely,” Cantrell says. They also knew it would be risky to manage a larger enterprise.

Ultimately, they decided to seek guidance from the professional management firm that had helped them with RHC certification. The physicians were advised to focus first on their long-range objectives.

Starting with the end in mind

The physicians developed goals answering the question: What do we want?

They wanted to maintain the autonomy of their two practices, improve revenue levels and maintain control of both treatment and management decisions. Since these answers were general, they worked out a list of objectives detailing how these goals could be met, and wrote a mission statement. Everything was colored by the nature of the marketplace, which was defined by the interaction of managed care organizations, Medicare regulations and other federal and state regulations.

The physicians' awareness that many compromises would probably be necessary along the way generated another goal: Whenever compromise becomes necessary, find a way to do it that leaves the physicians with the means to return to their original positions.

As their investigations went on, the physicians realized that they couldn't improve their position by negotiating with managed care carriers as separate entities. This was made abundantly clear when one of the town's specialists was deselected from an HMO's panel. “It wasn't his fault. It was just the nature of his practice,” recalls internist Tim Ellington. “We saw firsthand how a lone physician can get blocked out by managed care.”

A pair of corporations

Banding together with as many other area practices as possible was clearly the best solution. But how could they square this with their interest in maintaining the autonomy of their practices? The answer was not simple, but it was effective — a specially formulated professional association.

This professional association had to be a legally constituted entity that facilitated the merger of the practices — no arms-length, paper corporation. But even with a homegrown corporation, the question of autonomy remained: How could the practices align with such an entity and still maintain their independence? The answer was they couldn't, and that led to the first major compromise. The best they could do was to structure the new entity so that practices could withdraw from it intact, thus meeting their “escape hatch” goal.

The group enlisted Jenkens & Gilchrist in Dallas, a firm with extensive experience in structuring medical groups and a demonstrated understanding of today's marketplace to address the legal issues. Under the guidance of this firm and their management consultant, the physicians created a new corporation, Primary Care Associates, (PCA) in 1996.

Keeping the goal of autonomy in mind, the physicians established the following objectives:

• To create a practice appraisal method that would avoid capital gain taxation;

• To value practices according to tenets that match the values of managed care entities in order to maximize revenues;

• To develop a fair buy-in process and a buy-out process that would restore a withdrawing practice's identity and autonomy without undue expense to either PCA or the practice;

• To work out a method that would ensure each physician an equal level of control;

• To find a way to contract for management expertise while maintaining operational control.

Achieving these objectives called for a unique organizational structure utilizing the new corporation (PCA) and a management service organization (MSO) they called Professional Strategic Management Corporation (PSMC), which was created and owned by PCA. Rather than negotiating a classic practice purchase, PCA facilitates the merger of practices so that physicians can enter and exit the arrangement with no change in the value of their practices. The role of PSMC is to develop and implement a plan for the growth of PCA, to manage the day-to-day clinic operations and negotiate managed care contracts. (See “A winning model” for a general overview of these two operations.)

The merger process

Physicians joining the organization merge their practices with PCA in return for a combination of PCA stock and cash equivalent to the value of their practices. The criteria PCA uses to value a practice for merger purposes are different from those used in an open-market sale. PCA uses independent appraisers to value the practices according to their utility in the new organization.

A physician's value to the organization depends upon the number of active patients (patients who have been seen in the past two years) he or she brings to the association. Active patient records are valued at the current capitation rate. Merger costs are initially borne by PCA physicians. While each physician might hold a different number of shares in PCA, each physician is assigned a seat on the board of directors and one vote on motions before PCA.

While PCA purchases the medical records with PCA stock, each practice's nonmedical assets (everything except medical records) are exchanged for a set amount of PSMC stock per physician in the practice plus cash if the value of these assets exceeds $12,000. This stabilizes the PSMC share per physician. Thus each physician becomes a shareholder in both corporations.

Items of no value in managed care negotiations, such as complex laboratory equipment, equipment for procedures and high-visit volume, are not purchased. Gross production also was rejected as a valuation tool because the number of lives in the practice is the central issue in capitation, and a high number of visits per person per year can be detrimental. This limits the purchase to medical records, productive equipment and accounts receivable. PSMC also assumes lease agreements for equipment that generates revenue.

Physician compensation is dictated by site-specific revenue generation. Thus one practice's revenue stream can't affect another's income.

No reason is required to leave PCA. To date, no one has left, but if they do, departing physicians are required to leave as a group and go back to their original structure. The group simply sells its stock back for the value at the time the departing physicians joined. PSMC releases the group's equipment to them.

If one physician from a PCA member group wants to depart, a noncompete clause does pertain. The departing physician gets back all of his or her medical records for the price he or she was given for the original number of records. No additional value accrues to his or her PCA or PSMC stocks. (See “Building an escape hatch.”)

The thorniest issues: control and capital

The deliberations weren't all roses, and there were times when it felt to everyone involved that the effort might collapse. At one point, for example, the issue of control over management decisions looked like a dead end. Ultimately, the physicians decided to give the professional management firm an ownership share in PSMC equal to that of a physician member. PSMC then awarded the firm a contract for management of the MSO. The continuation of this contract depends upon annual economic results in comparison to a budget developed between PCA and PSMC.

Although the prime emphasis of all this effort was to improve the bottom line for the practices, it soon became apparent that the project itself would have a sizable price tag. Among other things, the physicians needed the resources to develop custom software and establish a new management team. Where would the money come from? This question brought them to the local hospital, an obvious choice because of its stake in the well-being of the primary care practices in the area.

The hospital was eager to help and agreed to loan PSMC enough money to meet its projected needs over four years. At the end of that time, the principal and interest would be converted into PSMC stock equal to 30 percent of the corporation's total value. This percentage was determined based on growth projections. If 30 percent of the value is less than the total amount due, then PSMC owes the hospital the balance. If it is more than the amount due, then the hospital may buy stock up to the 30 percent level. There are no personal guarantors, so none of the physicians is at risk. In case the hospital must attach the assets, the loan contract specifies that it must lease the equipment back to the physicians in the same condition as received, thus protecting their ability to earn an income and continue practicing in the community. The contract also stipulates that the hospital cannot exercise control over physician compensation, the operating budget, MSO operations, physician referral patterns or employee salaries.

The work goes on

PCA has grown from the original six family physicians to 32 providers. Of the 20 physician members, 11 are family physicians, five are pediatricians and four are internists. The remaining providers are midlevel practitioners, primarily physician assistants.

Joining forces has paid off. At the outset, capitation contracts stipulated a rate of $8.50 per member per month. Acting individually, the physicians couldn't budge the rate. Today the rate for the same services is over $16 thanks to the bargaining clout made possible by the consortium formed through PCA. Collections on fee-for-service patients have also risen as the result of astute management.

Other PCA practices have been certified as rural health clinics, and the introduction of midlevel providers has been a key factor in cost containment, increased patient volume and greater revenue in these practices.

Management issues are discussed at regular meetings. PCA's physician board of directors does set policy, but it has agreed that day-to-day decisions and operational strategies are the responsibility of the CEO of its MSO.

There are plenty of deliberations still to come. But the bottom line is that the bottom line is a lot better for everyone. “We have a say in our own destiny, and I now enjoy medicine more than I did 20 years ago,” Cantrell says. “I deal with administrative issues, but I don't need to make the solutions happen. I just go down the hall and take care of my patients.”