This article is more than 5 years old. Information may no longer be current.
Physician-owned distributorships face increased scrutiny
Click Here to Manage Email Alerts
Financial agreements in the health care industry can be complicated and lead to legal risk.
A case in point is physician-owned medical device distributors (PODs). The POD business model has proven both lucrative and controversial; proponents say that it is entirely legal and introduces pricing efficiency. Critics cite a conflict of interest and uncertain legality of the POD model.
Several articles in The Wall Street Journal (WSJ) have addressed the controversy linked to PODs. In the most recent one dated March, 26, 2013, WSJ reported that the federal government is examining PODs with heightened scrutiny, and will begin investigating these business entities. The purpose of this article is to alert readers to the risks associated with PODs and suggest steps to mitigate that risk.
Physician-owned distributorship
PODs involve a business agreement in which a group of physicians takes ownership of medical devices before the devices are sold to hospitals. Typically, a physician will buy an ownership share with the lure of high returns on the POD investment. The POD will then sell devices to the hospital(s) where the physician-investors perform surgery to implant the same devices. PODs, therefore, allow the physician to take a cut of profits ordinarily created in the retail channel of medical devices.
B. Sonny Bal
Lawrence H. Brenner
In the traditional supply business model, medical devices are sold to hospitals and surgical centers directly by manufacturers, with employee representatives or independent distributors as intermediaries. The intermediaries offer value-added services, such as order and delivery; stocking and restocking; sterilization; selection; instruments and support to surgeons in the operating room.
A POD can be set up so the physician-investors act as distributors, who buy devices from manufacturers and then resell them to the hospitals. Some PODs are structured as device manufacturers; these develop or modify products that are made by an outsourced vendor and then distributed by the POD. Other PODs are set up as a group purchasing organization that try to get lower prices from manufacturers by leveraging buying power and then sell the devices to hospitals.
PODs can be a lucrative source of ancillary income. The WSJ mentioned Portland neurosurgeon
Until recently, there had been few guidelines from the Department of Health and Human Services’ Office of Inspector General (OIG) concerning POD legality, licensure, and regulatory oversight. This is in contrast to other ancillary service arrangements that are of financial benefit to doctors, and where the law has offered more clarity, such as in-house radiology or physical therapy. The OIG and the Justice Department (DOJ) began to take a closer look at PODs in 2011 after a series of published articles appeared in WSJ about surgeons involved in such arrangements.
Now, in its most recent fraud alert, the OIG has taken a clear stance that PODs create substantial fraud and abuse risk, and may run afoul of the federal anti-kickback statute. The OIG is concerned that financial incentives from PODs may induce the physician-investors to do more surgery or more expensive surgery, and use POD-related devices preferentially over similar and equally effective devices.
Pros and cons of PODs
At least 20 states have multiple active PODs, including more than 40 PODs operating in California alone. Most are focused on orthopedic implants (spine and joint) and cardiac implants (pacemakers and defibrillators). POD growth has been driven by reductions in payments for physician services, and physicians’ desire to seek reliable ancillary revenue sources. Hospitals are pressured to do business with PODs to avoid the risk of losing referrals from their surgeons.
Proponents argue that PODs can save money by facilitating price negotiation, since the manufacturer can reduce or eliminate its marketing efforts. At the American Academy of Orthopaedic Surgeons Annual Meeting in 2009, for example, a California POD claimed to have saved its hospital 34% during a 2-year period on implant purchases with total savings of more than $1 million. Opponents counter that most PODs are shell entities, lacking infrastructure or capital investment, that unlawfully reward physicians for their control of surgical device selection.
Opponents also cite a conflict of interest in selecting implants that make money for the physician over those that benefit the patient. PODs may contribute to overuse of implant-based surgery. The Quality Implant Coalition reported that in 2007, spinal fusion revision rates increased more than 300% after a POD spinal product distributor moved into the hospital’s service area.
Other criticisms relate to PODs stifling competition since manufacturers and hospitals have a vested interest in pleasing their surgeon customers. While there may be an apparent cost-savings, the long-term effect of PODs is to increase costs and lower the quality of devices, consistent with the monopoly effect. Most seriously, by allowing physicians to financially profit from the devices their patients require, PODs may violate the federal anti-kickback statue or the Stark law prohibitions on compensation arrangements.
Legal view of PODs
Some lawyers maintain that absent regulatory guidance, properly-structured PODs are perfectly legal, do not create a conflict of interest, do not incentivize the use of substandard products and will not be eliminated by the government. Other lawyers have viewed PODs as inherently unlawful entanglements that raise substantial liability for physician-investors, and for the hospital and implant manufacturers who must “pay to play.”
The anti-kickback statute addresses fraud and abuse questions in health care. A person can violate this statute, for example, if just one purpose of a POD arrangement is to induce referrals for services or purchases of items reimbursable under a federal health care program. The Stark law is a federal statute that prohibits physicians who have financial relationships with entities from making referrals to those entities for the furnishing of “designated health services” reimbursable by a federally funded health care program.
CMS has not included physician-owned device or implant companies within the definition of a “designated health services” entity for purposes of the Stark law, although it has also cautioned that PODs may run afoul of the physician self-referral statute. To date, CMS has declined requests by large medical device manufacturers to ban PODs under the Stark law.
When hospitals buy devices from PODs, the purchase is considered a “designated health service” under the Stark law. Hospitals may be protected by the statute’s “indirect compensation” exception if they can demonstrate that any compensation provided from the hospital to the referring physician is fair market value for services and items provided, and if such compensation is not tied to referrals.
However, PODs create the risk of overuse, and may force patients to undergo unnecessary and invasive procedures. If these procedures are found to be not medically necessary or are found to improperly increase Medicare costs, this could implicate the hospital. The new OIG fraud alert is likely to cause hospitals to re-assess whether to continue doing business with PODs. In fact, many hospitals have already implemented policies restricting the purchase of medical devices from physician-owned entities. These include HCA Corp., Providence Health & Services, Tomball Regional Medical Center in Tomball, Texas; and Martin Memorial Health Systems in Stuart, Fla.
Governmental scrutiny of PODs
According to the Sunshine Provisions of the Patient Protection and Affordable Care Act, also known as the Sunshine Act, medical device and medical supply manufacturers must report to HHS the payments or transfers of value that they made to covered recipients. Based on CMS rules, PODs may be considered group purchasing organizations under the Sunshine Act, and therefore are subject to the reporting obligations if the rule is finalized as proposed. While Congress expressly excluded distributors from the Sunshine Act, to date, the CMS has not retreated from its interpretation in the proposed rule.
In June 2011, the Senate Finance Committee sent a report and letter to OIG requesting that the OIG investigate the legality of PODs under the anti-kickback statute. In turn, the OIG stepped up its review, particularly of PODs dealing with spinal implants. Specifically, the agency had said that it would review the extent to which hospitals purchase spinal implants from PODs, the types of services that PODs offer to hospitals, whether PODs save hospitals money in the acquisition of implants and whether PODs are associated with high use of spinal implants.
The fraud alert suggests that the OIG plans to carefully review the high use of orthopedic implant devices used in spinal-fusion procedures, specifically addressing Congress’ concerns that PODs could create conflicts of interest and safety issues. The PODs that are likely to be scrutinized are those that distribute substantial returns to physicians based on a small investment, limit their business only to physician investors, guarantee high returns on investment and result in more surgeries being performed by investors than were performed prior to the POD’s involvement. If a POD investment involves little or no financial risk for the physician, government regulators will be more likely to question the arrangement.
From a compliance perspective, concerns arise where financial return is related to the volume or value of investor referrals, even if individual return is based on a purchased fair market value investment interest. Scrutiny also will be forthcoming for investment opportunities that are offered to referring investors with no experience or management expertise in the medical device business.
A low-risk POD should equally compensate each physician-investor irrespective of individual usage or carve out the individual physician-investor’s personal usage from the profits that person receives. If a POD is not permitted to do business with its own investors, their partners or affiliated hospitals, then presumably the POD could replace a traditional distributor. It may be prudent to limit POD-related product use to procedures that are not federally reimbursable, and for multi-state PODs that only allow physician investors from one state to profit from physician investor usage in the other state(s).
Heightened POD scrutiny is consistent with the federal government’s efforts to identify and root out health care fraud. The WSJ articles are consistent with a trend to expose various financial arrangements that physicians have created among themselves or in partnership with device manufacturers and hospitals. According to WSJ, Senator Orrin Hatch (R-Utah) — the top Republican on the Senate Finance Committee, which exercises oversight of Medicare — asked the OIG to review the legality of PODs and he supports the OIG’s tough new stance. “Moving forward, I will continue to scrutinize these high-risk structures,” he said. “Our patients and American taxpayers deserve nothing less.” As part of its investigation, the DOJ has already served civil investigative demands on several POD surgeon-investors in California, and more will probably be forthcoming.
What do you think?
- Are PODs inherently unlawful, by creating a conflict of interest, and contributing to an increased incidence of implant-related surgery?
- Hospitals and manufacturers rely on surgeons to generate revenues. Is it ethical for physicians to leverage this inherently asymmetrical relationship to make money by creating PODs in which hospitals and manufacturers must participate to stay in business?
- Is it unreasonable for physician entrepreneurs to search for ancillary sources of revenue as practice-based incomes decline? If not, what are the outer contours of conduct that can guide physician participation in ancillary income streams in health care delivery and retail channels?
Discuss with your colleagues at www.OrthoMind.com.