Examining the legal hurdles of value-based contracts

Oct. 21, 2019
Quality can be difficult to define, measure

Value-based contracts are contracts in which the parties take into account the overall value of a product purchase to the buyer, not just the initial price. For example, a contract may have terms regarding long-term costs and benefits, such as the effect of the purchase on inpatient infections, readmissions and staffing requirements. There are substantial benefits from these types of contracts because they can provide assurances to hospitals that the eventual price they pay reflects the value they receive.

Value-based contracts provide a way to take quality into account. Every hospital wants to consider quality when it makes a purchase. But quality is difficult to measure, and it may even be difficult to define. A seller may claim to have clinical data that demonstrate its product will reduce inpatient infections or readmissions. However, it can be difficult for buyers to make these complex value assessments. Past performance data might be scarce or of dubious validity. What data are available may be old or may not apply to the precise product that is being purchased. Value-based contracts attempt to solve this problem by tying the eventual price to future performance. If they work, they create incentives for the seller to develop products that perform well and to provide guidance to the buyer about how the products should be used. At the same time, they create incentives for buyers to use the products in the most productive way.

There are obvious challenges in negotiating these contracts because they are more complex than a simple price negotiation. Legal and regulatory hurdles add to the challenge. Sometimes these hurdles accomplish legitimate goals of protecting patients and reducing wasteful government expenditures. However, many of these regulatory constraints originated when the overriding concern of regulators was fraud and abuse, and few people were thinking about the idea of value-based contracts. As a result, legal barriers can bar contracts that are good for patients and efficiency in the healthcare supply chain.

Healthcare supply chain executives, with the aid of legal counsel and perhaps other professionals, can usually work through the legal barriers. I’ll share possible ways of dealing with them and also examine a review of some of these regulations being conducted by the Department of Health and Human Services (HHS).

Value-based contract examples

A value-based contract can reward a seller for good product performance, punish a seller for bad product performance, or allocate the risk of poor outcomes between the buyer and seller. Below, I describe examples of value-based contracts that were the subject of Advisory Opinions issued by HHS’s Office of Inspector General (OIG). They illustrate some of the legal hurdles these contracts can encounter.

Warranty Program for Readmissions (Advisory Opinion 18-10). A seller of a suite of products used in joint replacement provided a warranty to hospitals to reimburse the hospital for the cost of three products if a patient was readmitted because of an infection or need for a surgical revision. The seller wanted to encourage the hospital to buy the bundle of products – the implant itself, a wound therapy system and an antimicrobial dressing. The seller’s expectation was that, by using the three products together, there would be a better outcome.

Outside the healthcare context, such a warranty would not raise any legal hurdles. But regulators have long worried that a benefit offered by a seller to a provider might encourage the provider to distort clinical decision-making, driving up the costs of care. These kinds of harmful incentives are prohibited by the Anti-kickback Statute (AKS), which makes it a criminal offense to knowingly and willfully offer something of value to induce a purchase of a product or service reimbursed by Medicare or Medicaid.1

If that section was literally applied to all transactions, it would bar many efficient and harmless efforts by a seller to make its product more attractive. After all, the central purpose of selling anything is to “induce” a purchase. In order to avoid the overly broad reach of the AKS as well as other statutory restrictions, HHS has the authority to promulgate safe harbors for transactions that are unlikely to result in fraud and abuse.2 Unfortunately, these safe harbors do not apply to all categories of contracts that are good for patients and the healthcare system, and, even if they might apply, the specific requirements of the safe harbor are often too narrow and rigid to be of benefit.

In the above example, there is an existing “warranty safe harbor” recognized by OIG that might apply. However, the literal terms of the warranty safe harbor apply only to single products, not to a bundle of products. Nevertheless, OIG approved the arrangement for several reasons: 1) since Medicare reimbursed the hospital for the entire suite of products with a single payment, the hospital could not mix and match different products but had to choose the bundle of products that offered the best value; 2) because the terms of the warranty program were fully transparent, the hospital would have to report any savings to Medicare and could not receive excessive reimbursement; 3) the physicians had to certify that all the products in the suite were medically necessary, thus avoiding the risk of overutilization; 4) the arrangement offered the possibility of reducing infections and readmissions; and 5) there were no exclusivity requirements.

Sharing savings with surgeons (Advisory Opinion 17-09). Neurosurgeons agreed to implement cost-savings measures in return for a share of the savings from the changes. The cost-savings measures included limiting the use of Bone Morphogenetic Protein to a target percentage of spine surgeries and to take steps to standardize certain devices and supplies. The OIG reviewed the arrangement as a possible violation of the AKS as well as the “Gainsharing CMP,” which prohibits hospitals from making payments to physicians to reduce services. The OIG approved the plan on the theory that the plan was unlikely to result in inducing referrals of patients to the hospital (the AKS concern) or reduce clinically necessary services provided to patients (the Gainsharing concern).

Replacing spoiled products (Advisory Opinion 17-03). This arrangement involved a pharmaceutical manufacturer promising to replace products that required specialized handling and became unusable due to spoilage. The commitment applied even if the buyer was responsible. (There was an exception if the spoilage was caused by a refrigeration failure.) OIG said the arrangement did not fit in the warranty safe harbor because the replacement could occur even if there was no defect in the product. OIG still approved the arrangement because there appeared to be little risk of overutilization, it had little effect on the purchase decision, and it “bore some similarity to an insurance policy.”

Refunds if coverage unavailable (Advisory Opinion 2-06). A seller of a blood-filtering device agreed to refund the cost of the device if the purchasing hospital could not obtain reimbursement for the purchase. OIG again found that the arrangement did not fit within the warranty safe harbor, in this case because it was not related to product failure. Nevertheless, OIG approved the arrangement in part because the reimbursement guarantee was limited in time and limited to the cost of item. It did not extend to any other patient care expenses that the hospital incurred related to the therapy. (This is a frequent case where better terms offered to the buyer would have made OIG approval less likely.)

Spotting the legal barriers

Several legal barriers may pose challenges to innovative value-based contracts. They include:

State law insurance regulation. If the provider ends up assuming the risk for the costs of healthcare services, state law may treat the provider as subject to insurance regulation and require monitoring of its financial solvency or becoming licensed as an insurance entity. HHS is not addressing state law issues, and I do not discuss these below. However, it is important for any entity that can be viewed as assuming risk for the costs of healthcare to consider them.

The AKS. The Anti-kickback Statute is probably the most significant hurdle to overcome because many value-based contracts will provide benefits to buyers that could be viewed as an unlawful “inducement.” AKS considerations come up whenever a supplier includes a special provision in a contract that might be viewed as an improper inducement to the hospital to purchase the supplier’s products. It also comes up when the hospital provides benefits to physicians that might be viewed as an improper inducement to the physicians to make referrals to the hospital.

The Physician Self-Referral Law (Stark). Federal law prohibits certain types of “self-referrals” by providers, e.g., physicians referring patients to another provider owned by the physician or in which she has a significant interest.3

The Civil Monetary Penalties Statute (Beneficiary Inducement). This provision bars remuneration to a beneficiary that is likely to influence the beneficiary’s selection of a provider.4 For example, the provision can bar waiving a Medicare beneficiary’s cost-sharing.

The Civil Monetary Penalties Statute (Gainsharing). This provision bars improper payments by a hospital to physicians to reduce utilization.5 For example, innovative programs by hospitals that compensate physicians to encourage product standardization or use certain treatment protocols may implicate this provision.

Lessons from the OIG Opinions

The OIG reviews above suggest how the current system makes it more difficult to structure value-based contracts. They illustrate the cumbersomeness of a regulatory system that is based on broad prohibitions and exceptions embodied in “safe harbors.” The broad prohibitions are weighted too heavily toward preventing fraud and abuse compared to the weight given to the potential for reducing costs and improving care. At the same time, the safe harbor exceptions are too narrow and technical. The result of the OIG review in these cases was positive, but the effort required to obtain an advisory opinion and to comply strictly with OIG’s requirements is significant. It will usually be impractical to undergo the time and expense needed for an OIG opinion.

The OIG cases do suggest some lessons for parties considering value-based contracts.

  • First, try to fit the contract within an existing safe harbor. If it does not meet the technical requirements of the safe harbor, structure it to come as close as possible.
  • Second, if there is an AKS concern, draft the contract to address the underlying policy concerns of the AKS. For example, build in protections to avoid overutilization and to ensure services are medically necessary. Avoid exclusivity provisions that tie doctors to a particular product. Limit the benefits to the buyer to those essential to accomplishing the objectives of the contract. Ensure that there is transparency in reporting provider savings to CMS and that the dollar flows are fully documented. These same considerations apply if there is a “beneficiary inducement” concern, i.e., encouraging patients to choose a provider based on a waiver of cost-sharing.
  • Third, if there is a gainsharing concern, then build in provisions to avoid reducing necessary services to patients. For example, commit to follow recognized treatment protocols and give physicians options to choose any necessary products and services. Frequently, legal counsel will have to be consulted to navigate the regulatory challenges.

Current legal framework, HHS review challenges

HHS is now conducting a review of two provisions, the AKS and the CMP beneficiary inducement provision.6 HHS assumes, probably correctly, that the regulatory framework will continue to rely on safe harbors that serve as exceptions to these broad prohibitions. Comments to HHS include suggestions about how to make the regulatory system more amenable to value-based contracts. These include:

  1. Making the discount safe harbor more flexible by eliminating the requirements that: a) any discount or rebate occur within one year; b) the specific value of the discount be specified at the beginning of the contract period; c) the discount must be conditioned only on a simple purchase; and d) all components of the sale must be reimbursed under the same program.
  2. Eliminating the requirement under the safe harbor for gainsharing arrangements that the fair market value of the remuneration be determined in advance.
  3. Making the warranty safe harbor more flexible by extending it to cover bundled products and arrangements in which the trigger for the warranty is not strictly a product defect.

Other suggestions involve creating broad new safe harbors that deal with innovative contracts, including a safe harbor for a value-based alternative payment model,7 value-based pricing, value-based warranties and value-based risk-sharing arrangements.8 No doubt, specifying the limitations of these safe harbors and the situations where they apply will present challenges. This area of the law is already plagued by undue complexity and creating more safe harbors (and defining them) risks making the regulatory framework even more complicated. Still, there may be no alternative, given the history that has led us to where we are. In the meantime, buyers and sellers must work around these hurdles as best they can.

1. Section 1128B(b) of the Social Security Act; 42 U.S.C. § 1320a-7b(b).
2. See 42 C.F.R. § 1001.952.
3. 42 U.S.C. § 1395nn.
4. 42 U.S.C. 1320a-7a(a).
5. 42 U.S.C. § 1320a-7a(b).
6. See 83 F.R. 168, 43,607 (Aug. 27, 2018). HHS also previously requested comments on other safe harbors. 82 F.R. 61,229 (Dec. 27, 2017).
7. See the comments of the American Association of Medical Colleges.
8. See the comments of the Advanced Medical Technology Association (AdvaMed).
About the Author

Edward Correia

Edward Correia is a Washington, D.C. attorney and partner in Correia & Osolinik. His practice includes antitrust, health care regulation and federal and state accessibility requirements for persons with disabilities. His clients include AdvaMed and the Strategic Marketplace Initiative (SMI). He is also an Adjunct Professor at American University’s Washington College of Law. He can be reached at 301/943-8647 and [email protected].

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