United States: Beyond Gainsharing: Physician Ownership of Medical Product Distribution Channel Entities

For most medical products, pricing and distribution relationships have historically been relatively straightforward. Manufacturers sold their products to wholesalers or directly to end-user institutional customers and offered discounted pricing based on volume-related measures to these purchasers directly or through group purchasing organizations.

An exception to this general paradigm, however, has been so-called "physician preference" items. Physician preference items are medical products—often implantable medical devices—for which physicians insist on their ability to select the particular brand or item to be used for a particular patient. As a result, institutional purchasers who actually pay for such items have had limited success attempting to implement formularies or standardize utilization patterns so as to secure volume-based discounts from manufacturers. Some have criticized this paradigm as facilitating other types of inappropriate relationships between manufacturers and physicians.

The Office of Inspector General’s recent advisory opinions concerning "gainsharing" arrangements reflect one approach to addressing the tension between institutional purchasing personnel on the one hand and surgeons on the other, by authorizing hospitals to share a portion of savings associated with certain practice and product standardization protocols with participating physicians. In these arrangements, the OIG authorized hospitals to share a portion of savings associated with the implementation of cost-sharing protocols, including recommendations to use particular devices where medically appropriate, under a strict set of controls.

In particular, the OIG stated that the arrangements had sufficient controls in place so as not to present a substantial risk of reducing or limiting services to beneficiaries in light of the civil money penalty provisions at 42 U.S.C. § 1320a-7a(b)(1)-(2). Further, the OIG indicated that it would not impose sanctions under the federal anti-kickback statute because the limited and controlled nature of the relationship did not pose a significant risk of inducing physician referrals to the hospitals. The OIG did not address implications of the arrangements under Stark II. Nevertheless, the OIG’s "gainsharing" opinions reflect limited acceptance of the principle that some sharing of savings between hospitals and physicians associated with specific cost-savings standardization programs, under strict controls to protect beneficiaries, is appropriate.

Recently, however, a variety of new organizations has sought to expand the principles in the OIG’s opinions by creating new models for "aligning" financial incentives and physician preferences. Rather than addressing physician-hospital relationships, however, these new models focus on the distribution channel and involve the creation of various types of joint ventures with physician owners. The models include physician-owned joint venture manufacturers, distributors, group purchasing organizations, and sales agent organizations.

In essence, these new joint venture entities seek discounted pricing and/or administrative fees from manufacturers based on the ventures’ ability to promote product standardization. These savings may (or may not) be passed through to institutions in whole or in part through various mechanisms. However, product resale margins or other manufacturer-derived revenue, such as administrative fees, could be distributed to physicians as investment returns.

Physicians, hospitals, and manufacturers should recognize that many of these arrangements are in fact "beyond" gainsharing, and they should be extremely cautious about expanding the principles in the OIG’s recent advisory opinions to these types of organizations. Most significantly, the OIG’s opinions focus solely on relationships between physicians and hospitals under a tightly defined set of controls, where the savings to be shared is derived from the hospital that pays the costs for medical products and is otherwise responsible for assuring quality care. While these and similar issues are also present in the emerging distribution relationships (e.g., has a hospital given an entity a distribution business opportunity in order to encourage or maintain referrals from the physician owners?), the new arrangements present a completely separate set of issues arising from the relationship between the physician organizations and manufacturers.

Manufacturer/physician organization relationships should be carefully reviewed under both anti-kickback and price regulation principles. For example, if a physician organization does not meet the joint venture safe harbor or if it conflicts with other OIG special fraud alerts and bulletins on joint venture arrangements, the arrangement may be viewed as an indirect conduit for remuneration between the manufacturer and the physician-owners in order to induce the use of the manufacturer’s products as "standardized" items. Similarly, more favorable discounts to physician distribution entities may raise issues for manufacturers under the Robinson-Patman Act. Other factors to consider are whether the entity actually adds value to the distribution chain independent of its physician-owners (e.g., does the entity actually engage in the core distribution entity functions? does the manufacturer enter into arrangements with similar entities that are not owned by physicians?), and whether the geographic or institutional scope of the arrangement is closely aligned with the practice area or institutions of the physician-owners.

The lack of alignment between purchasers and physicians under the existing "physician preference" system poses legitimate issues of health care cost-containment policy. Nevertheless, while we do not mean to suggest that physician ownership in distribution entities is never appropriate, the parties in the distribution and product selection chain should approach these new models with great care, and at a minimum, must recognize that the OIG’s gainsharing advisory opinions do not fully address the issues these new models present.

This article is presented for informational purposes only and is not intended to constitute legal advice.