David W. Barby Latham & Watkins LLP Costa Mesa, CA 714.755.8262 david.barby@lw.com

1. The Southern California Chapter of The Healthcare Financial Management AssociationCo-sponsored by Southern California AAHAMCFO Forum Committee: Breakout Session #1Dealing With Physician Call Coverage Compensation Costs Paul R. DeMuroLatham & Watkins LLPLos Angeles, CA213.891.7330paul.demuro@lw.com David W. BarbyLatham & Watkins LLPCosta Mesa, CA714.755.8262david.barby@lw.com Long Beach, CAAugust 16, 2007

2. Good Old Days – Background Hospital Medical Staff Bylaws Required That Physicians Be On Call and They Actually Showed Up Without Compensation Exceptions Often Existed for Age (e.g., 60) and Years of Service (e.g., 25) or Some Combination Thereof

3. Good Old Days – Background Some Hospitals Perceived that Paying MDs for On-Call Would Be Problematic - e.g., Paying MDs for a service that they were already required to provide

4. Good Old Days – Background Many Physicians Believed that Being On-Call without Pay Was Just Part of Their Responsibility as a Medical Staff Member - e.g., It was a quid pro quo for obtaining medical staff privileges

5. Good Old Days – Background There Also Was Cost-based Medicare and Medi-Cal Reimbursement for Hospitals, Little or No Managed Care and Significantly Less Consolidation Thus, We Were Living with the Easter Bunny, Santa Claus and the Tooth Fairy

6. You Had Too Be There to See This!

7. Miscellaneous Regulatory Issues Prohibition Against Subsidizing Payments for Medicaid (Medi-Cal) Patients No Payments for the Referral of Patients to a Hospital (Medicare and Medicaid Antikickback and Stark Self-Referral Considerations)

8. Miscellaneous Regulatory Issues Antitrust Considerations Regarding Physicians Refusing to Provide On-Call Coverage En Masse No Payments that Are Not Fair Market Value for Services Rendered by Physicians Tax-Exempt Hospitals Also Have Inurement and Private Benefit Considerations

9. What Changed? EMTALA Required Certain Patients Who Presented at the ED, Resulting Hospitals to Stabilize and Treat in the Potential for Greater Liability for Hospitals Physicians Perceived Their Incomes Were Declining - Medicare and Medi-Cal reimbursements did not keep pace with the increase in medical practice costs

10. What Changed? - Managed care companies exerted downward pressure on commercial reimbursement payments to physicians - More and more patients were underinsured or uninsured, including many undocumented persons in California

11. What Changed? - MDs got tired of getting up in the middle of the night to come into the hospital to see no pay patients - A new generation of physicians came onto the scene - Physicians discussed among themselves how much they did not like being on call and having to come into the hospital to treat no pay patients, underinsured patients and Medi-Cal patients

12. What Changed? Medical Staffs Looked at Trying to Eliminate the Medical Staff Bylaw Requirement that All Physicians Provide On-Call Services to the Hospital ED Without Compensation (Subject to Certain Exception) Hospitals Became Quite Concerned that They Might Not Be Able to Keep Their EDs Open and Became Concerned about EMTALA Liability

13. What Changed? Some MDs Who Did Not Need to Practice at the Hospital Resigned from the Medical Staff, Eliminating Their Requirement that They Be On-Call

14. What Changed? Hospitals Flinched and Started to Look at Ways to Compensate MDs - The CEO, CFO and board of the local community hospital did not want to be the ones in the news with negative press - Hospitals did not want to risk the liability associated with not having sufficient MD coverage in the ED

15. What Changed? - Hospitals did not want their MDs resigning from their medical staff, walking across the street to the hospital that would compensate them

16. What Changed? Thus, Conditions Were Ripe for the Perfect Storm Hospitals that thought they could pay a few MDs specialties a few hundred dollars a day began paying all specialties hundreds to thousands of dollars a day with payments totaling millions, if not tens of millions of dollars per year, for services that they had been getting for nothing just years ago.

17. You Had Too Be There to See This!

18. Numerous Methods To Compensate Physicians Were Developed, Including: Payment of Stand-By Fees by Medical Specialty (probably the most common today) Payments for Uncompensated Care Patients (e.g., at the Medicaid rate)

19. Numerous Methods To Compensate Physicians Were Developed, Including: Contract with One or More Medical Groups for ED coverage - Group pays the individual MDs in the Group Creation of a Pool of Funds Administered by the Hospital/Medical Staff or Some Combination Thereof 457 Deferred Compensation Plans

20. Need to Determine Fair Market Value What Are Other Hospitals Paying? - By specialty? (But is this not just like the executive compensation cycle?) Need for a Fair Market Value Determination by an Independent Consultant?

21. But What If Certain Physicians Just Hold Out? That Is, What if the MDs Will Not Contract at any Price? And, a Hospital May Face Difficulties Trying to Recruit MDs in a Specialty to Be On-Call When There Are Sufficient Physicians of that Specialty in the Community Because of Legal Restrictions Antitrust Considerations May Be Real, But Not Practical

22. Would the CEO or CFO of a Community Hospital Really Refer the Physicians on the Hospital Medical Staff to the Federal Trade Commission (FTC) for Possible Action or the Department of Justice (DOJ), Antitrust Division for Prosecution? Such a Referral Could Be the Last Act of that Individual as an Employed Individual

23. A New Alternative 457 Deferred Compensation Plans - Have been in existence for years, but only recently have been employed as an alternative to traditional ED on-call payment methodologies

24. 457 Deferred Compensation Plans • Section 457 of the Internal Revenue Code applies special federal income tax rules to nonqualified deferred compensation provided by a tax-exempt organization • For example, Section 457 applies to nonqualified deferred compensation provided by a hospital that is a tax exempt organization under Section 501(c)(3) of the Internal Revenue Code - Section 457 does not apply to qualified plans (i.e., qualified pension and 401(k) plans)

25. 457 Deferred Compensation Plans -Nonqualified deferred compensation generally means compensation earned by an employee or independent contractor that is to be paid in a future taxable year - Section 457 of the Internal Revenue Code applies two sets of rules to nonqualified deferred compensation – Section 457(a) and Section 457(f)

26. 457 Deferred Compensation Plans • Section 457(a) of the Internal Revenue Code applies to an “eligible deferred compensation plan” - An “eligible deferred compensation plan” must satisfy certain requirements under Section 457(b), including limitations on the amount of compensation deferred and the distribution of the deferred compensation

27. 457 Deferred Compensation Plans • Compensation deferred under an “eligible deferred compensation plan” generally is taxed when paid to the employee or independent contractor - Section 457(f) of the Internal Revenue Code applies to all other plans, agreements or arrangements - Compensation deferred under a Section 457(f) plan, agreement or arrangement is taxed when there is no “substantial risk of forfeiture” on the employee’s or independent contractor’s right to the deferred compensation

28. 457 Deferred Compensation Plans - Compensation is subject to a “substantial risk of forfeiture” if the employee’s or independent contractor’s right to the compensation is conditioned on the future performance of substantial services by an individual - This generally means that deferred compensation is not taxed until the employee or independent contractor has a vested and nonforfeitable right to the compensation

29. 457 Deferred Compensation Plans • The deferred compensation is taxed when the employee’s or independent contractor’s rights become vested and nonforfeitable, even if the compensation is not paid until a later taxable year -For example, if the compensation agreement with a physician provides that the physician’s “on call” fees will be deferred, the agreement may be subject to Section 457(f) of the Internal Revenue Code

30. 457 Deferred Compensation Plans - If the physician must perform substantial “on call” services in the future to retain the right to the deferred fees, the deferred fees would not be vested and nonforfeitable and should not be taxed - In this case, if the physician fails to perform the required “on call” services, the deferred fees would be forfeited - The deferred fees should be taxed when the physician is no longer required to perform substantial services

31. New Internal Revenue Service Notice -On July 23, 2007, the Internal Revenue Service issued Notice 2007-62, which describes anticipated future guidance concerning Section 457(f) of the Internal Revenue Code - The future guidance is expected to include additional guidance regarding the definition of “substantial risk of forfeiture”

32. New Internal Revenue Service Notice - The Internal Revenue Service guidance is expected to provide that compensation generally is not subject to a “substantial risk of forfeiture” beyond the date when the employee or independent contractor could have elected to receive the compensation - For example, if a physician is given an election between the current payment of “on call” fees, and the deferred payment of fees subject to a forfeiture risk (based on a requirement to provide future services), the deferred fees would not be treated as subject to a “substantial risk of forfeiture”

33. New Internal Revenue Service Notice • Absent the “substantial risk of forfeiture,” the deferred fees in this example would be taxed immediately • The Internal Revenue Service guidance is expected to permit an election, however, if the deferred compensation has a materially greater present value than the current compensation • In the example, a physician could be given an election between the current payment of “on call” fees, and a deferred payment of fees subject to a risk of forfeiture, if the deferred fees have a materially greater present value

34. Section 409A of the Internal Revenue Code - Section 409A of the Internal Revenue Code applies additional rules to nonqualified deferred compensation plans, agreements and arrangements (including those maintained by tax exempt organizations) - The rules under Section 409A apply in addition to the rules under Section 457(f) - The Internal Revenue Service recently issued final regulations under Section 409A, which should be considered in analyzing any nonqualified deferred compensation plan, agreement or arrangement subject to Section 457(f)

35. 457(f) Plan Design Issues forOn-Call Payments • Possible Forfeiture Events • Failure to take call duties • Resignation • Dropping out of specified insurance programs

36. 457(f) Plan Design Issues forOn-Call Payments • Vesting Options • Typically a pre-determined period of years • Provide incentive for continued service to hospital

37. 457(f) Plan Design Issues forOn-Call Payments • Funding • No obligation to currently fund arrangements • Rabbi Trust • Other funding alternatives

38. 457(f) Plan Design Issues forOn-Call Payments • Plans may permit participants to direct investment of deferred compensation amounts • Arrangements may be customized to meet differing needs of different groups of physicians