Fair Market Valuation of Accountable Care Organizations

An accountable care organization (“ACO”) is a healthcare delivery entity characterized by a payment model that facilitates coordination among providers — charged with the care of a specified patient population.

Participation in an ACO is voluntary, and participants must be willing to become accountable for the quality, cost, and overall care of the specified population. Commonly, ACOs receive capitated payments based on the size of the patient population served, though other reimbursement models exist. ACO participants are financially incentivized to lower healthcare costs while improving quality as they share in a portion of the excess between total capitated payments and total healthcare costs.

ACOs are either Federal or commercial, providing care to either Medicare beneficiaries or participants in commercial health insurance plans, respectively. In December 2018, Centers for Medicare and Medicaid Services (CMS) released new guidelines for Federal ACOs called “Pathways to Success.” Perhaps the most significant development from Pathways to Success was the ushering of Federal ACOs currently operating without downside financial risk to models that include downside risk (and greater potential savings splits). Operating with downside risk forces Federal ACOs that spend more than they collect in revenue to pay a portion of the deficit to CMS.

There are currently 472 Federal ACOs in existence, and 284 achieved positive shared savings in 2017 (159 of which saved enough to receive shared savings bonuses in 2017). Of these, only 39 were participating in ACO tracks involving downside risk. For 2017, there were 101 hospital-led ACOs, 209 physician group-led ACOs, and 162 integrated ACOs.¹

In very recent periods, we have noticed a consolidation trend as ACOs aim to increase their patient population sizes in hopes to garner additional shared savings and capitalize on economies of scale. We have also noted several transactions involving ACOs across state lines, an interesting trend from a strategic perspective. As many ACOs’ capitalization tables include physician and hospital ownership, transactions of ACO ownership likely must be consistent with fair market value. Due to the complexity and “greenfield” nature of ACOs, it often behooves the involved parties to engage a valuation expert to assist. 

Valuation of ACOs

Like any business enterprise, valuators consider the application of the income, market, and asset approaches, and the numerous methods associated thereunder. Although we are aware of recent transaction activity, many of the crucial details surrounding these transactions are not available. As such, the application of the market approach is generally not relied upon. The application of the income and asset approaches depends largely upon the operational reality of the ACO. If the ACO has achieved positive savings and/or is expected to do so going forward, it may be advantageous to consider the income approach. Under the income approach, the expected future economic benefits accruing to the ACO are first projected and then discounted to the present date using a discount rate or capitalization rate, depending on the number of periods projected.

The discount rate or capitalization rate considers the time value of money as well as additional risk factors for investment in capital markets, size, industry, and other qualitative factors. Due to the highly regulated and dynamic nature of ACOs, we normally observe higher discount/capitalization rates compared to other types of healthcare enterprises, all else equal. In particular, there is substantial risk in determining a “terminal value,” which can and often does comprise a relatively high proportion of total invested capital. Such substantial risk stems from the regulatory uncertainty surrounding ACOs in perpetuity. 

When considering the application of the income approach to value an ACO, one must consider the current operating agreement. Certain ACOs elect to pay substantially all of the available savings to participants in the form of guaranteed payments, leaving very little profits available to a hypothetical investor. Conversely, ACOs may elect to retain all shared savings as profits, leaving more economic benefits to be discounted to present. To the total participants who are also investors, the choice to distribute shared savings via guaranteed payments or to retain as profits (to then distribute) is less consequential. However, to a hypothetical investor who need not be a participant, the choice on how to treat the shared savings has a substantial impact on the value of the ACO. 

If the ACO has not achieved shared savings but is nevertheless expected to operate into the foreseeable future, the valuator may consider the application of the asset approach. The asset approach determines the value of a business enterprise by referencing the values of assets (net of liabilities if applicable to deal terms) on the balance sheet. In the context of fair market value, consideration must also be given to any off-balance sheet assets or liabilities that may be present. Such assets in the context of ACO valuation may include internally care management programs and other protocols. The valuator then determines the fair market value of any off-balance sheet intangible assets using any or a combination of the income, market, and asset (cost) approaches mentioned above.

The valuator must also consider the application of discounts for lack of control and/or marketability if appropriate to the valuation assignment. 

In summary, the valuation of ACOs requires independent professional judgment. Apart from being closely held entities, for which no price discovery is available, the ACO industry is highly dynamic and regulated. Very little market data is available from a transaction standpoint. Particular attention needs to be paid to the existing operating agreement and the process to distribute shared savings to participants, owners, or both. Valuation of the enterprise generally involves the application of the income, market and asset approaches, or a combination of these.

My view is that ACO transaction activity will substantially increase in the near term, as ACOs that have been operating for several years begin to differentiate themselves on how effectively they translate clinical data into efficiency and profits. In addition to majority interest transactions, minority interest transactions are likely to abound as aging physicians desire to liquidate their investments. Enterprising ACOs can make many uses of the publicly available information of other ACOs, a unique aspect of the ACO industry.

¹ HealthAffairs Blog – “Half A Decade In, Medicare Accountable Care Organizations Are Generating Net Savings: Part 1”. William K. Bleser, David Muhlestein, Robert S. Saunders, Mark B. McClellan