Fair Market Value

Jan 01, 2009
By Pharmaceutical Executive Editors

Ann Brandt
Eli Lilly was one of the first major drug makers to voluntarily report payments to physicians. Today, other Big Pharmas are following sui, and it's no surprise. The Office of Inspector General (OIG) has hit medical device and pharmaceutical industries with multimillion dollar fines for violating fair market value standards; in fact, that's one main reason Daryl Johnson founded HealthCare Appraisers. Cultivating experience from work on the provider side of healthcare, a national medical oncology group, and practice management companies, Johnson started his own specialized healthcare consulting firm. Over time, the company received several projects from the life sciences industry, and it became clear to that fair market value ran the same fine line for both the hospital sector and the life sciences.

Since there is no government approved standard to determine fair market value, what can industry rely on?

Daryl Johnson
Daryl Johnson: That's one of the major problems. There was a brief period when the federal government created safe harbor rates for hourly compensation arrangements with physicians, but those tended to be very low. They were of limited usefulness to companies making payments to physicians, and subsequently the federal government rescinded them.

Pharmaceutical companies are required to comply with the fair market standard, but the government sets forth very limited guidance in terms of how fair market value should be determined. One key area of guidance in the area of fair market value is the emphasis on not placing reliance on market rates. There is specific guidance from the government that cautions companies not to rely on values that may represent an overcompensation bias.

Ann Brandt: I think pharmaceutical companies are beginning to look at areas they didn't heavily focus on before. Anecdotal evidence suggested that physicians would ask for what they wanted, whether for a particular role within the company or in advisory services or educational areas, so it was more of a pharmaceutical company responding to their requests.

What has changed since the fair market value yard stick was created? Have companies reorganized to remain compliant?

AB: Increased scrutiny has come down on the medical device industry and within hospital provider markets, and now more heavily of in the pharmaceutical market. I think [this scrutiny] has changed the way arrangements are made. They've changed the way pharmaceutical companies interact with their physicians and thought leaders.

Is there a "best" way to measure value?

DJ: The best approach is to rely on the knowledge base of fair market value that exists in other settings. Fair market value is a term of art. It's generally defined as a value negotiated at arm's length between a hypothetical willing buyer and a hypothetical willing seller. The IRS has very clear guidelines on methodologies that are acceptable from the standpoint of a fair market value standard. Those standards and the fair market value body of knowledge can generally be cross-walked to the determination of the fair market value of a compensation arrangement. For example, with traditional business valuations the primary approaches are cost, income, and market. Likewise, in a compensation valuation setting, consideration can be given to the same three valuation approaches—so we're using the guidelines and the techniques that were developed in business valuations and applying them to compensation valuation.

How have thought leaders responded to these changes? Has it directly impacted relationships with doctors?

AB: The reality is that thought leaders are not necessarily happy with changes, because the changes tend to limit their compensation. Now, with the government looking over everybody's shoulder, pharma has to say, "We can't pay you any more than X amount." Oftentimes, that is a benefit of going to a third party valuation company. A pharma can say, "Well, the valuators said we can't pay you more than this amount of money," so it sort shifts some of the blame.

Also, the government is starting to put the brakes on granting unlimited amounts of money that could look like referrals. This has affected pharmaceutical programs. One of the issues we run into is how to compensate for the time that it takes a physician to travel to a venue. What is the appropriate way to value that time? We've had some interesting debates. We tend to not value it as highly as when they are actually engaged in whatever function they are hired for, because their expertise is worth more when they are delivering something of value. However, you have to compensate for that time because it takes them away from their practice. Which brings up other interesting point: Do you compensate somebody for what they would make in their clinical practice, or do you compensate them at the same rate when they are doing something more administrative?

DJ: Among guidance from the government, I mentioned that reliance on market values might contain an overcompensation bias. Another specific area relates to the issue of opportunity cost. The government is pointing out that the value of clinical services and the value of administrative services may not be the same so that's a key aspect of guidance in establishing fair market value.

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