Life Sciences: Compensation Valuation in an Age of Transparency

The life sciences industry is dealing with a series of global challenges relating to increasing competition, escalating costs and expanding regulatory requirements. New regulations, focusing on requirements for transparent interactions between life sciences companies (“LSCs”), physicians and other types of healthcare providers (e.g., pharmacists, basic science researchers, physicists, etc., and together with physicians, the “Healthcare Providers” or “HCPs”), are being implemented by governments and industry associations throughout the world. Anti-corruption laws (e.g., The Foreign Corrupt Practices Act[1] in the U.S. and the U.K. Bribery Act[2]), which provide criminal penalties for violations, are now more easily enforced with the implementation of the new transparency requirements.

RELATIONSHIPS BETWEEN HEALTHCARE PROFESSIONALS AND LIFE SCIENCES COMPANIES

One of the most significant areas of global scrutiny involves the relatively symbiotic relationship between physicians, life sciences companies (“LSCs”) and the products these companies develop (i.e., physicians who provide services to, and are compensated by LSCs, may also be referral sources for the healthcare goods and services provided by LSCs). Yet, LSCs regularly engage physicians and others (i.e., the HCPs) to advise, consult, teach, speak or conduct research related to their products and services. Payments to HCPs for these types of services, which can total millions of dollars per year, have become routine expenses for LSCs.

Experienced HCPs offer a level of expertise and understanding that often cannot be duplicated by any other group of professionals. Their clinical knowledge and experience is often critical to the development, commercialization and effective use of LSC products and services. Furthermore, research indicates that clinicians pay more attention to what other clinicians say than to what sales reps say about a drug or device. Therefore, when LSCs want to educate HCPs about new treatments, products and their applications, they often engage the services of experienced HCPs to deliver informational programs to their counterparts in the community.

However, in recognition of potential conflicts of interest, regulators throughout the world are implementing laws to prevent inappropriate financial relationships between HCPs and LSCs. New regulations are emerging that focus on various types of service arrangements to determine whether they may be linked to prescribing practices or to usage patterns involving the LSCs’ products. Of particular significance is whether the fees for these services appear to be in excess of fair market value for the services rendered. Worldwide interest in transparency and fair market value are very much a response to the realities that accompany the globalization of healthcare; therefore, it must be assumed that these requirements will become part of the daily demands of doing business for LSCs.

THE REGULATORY ENVIRONMENT WITHIN THE U.S.
THE PHYSICIAN PAYMENTS SUNSHINE ACT (THE “SUNSHINE ACT”)

The Sunshine Act, which was included as Section 6002 of the Patient Protection and Affordable Care Act of 2010 (PPACA), requires manufacturers of drugs, biological products, medical devices, and medical supplies to track and report to the U.S. Department of Health and Human Services (HHS) certain payments and other transfers of value[3] that they provide to physicians[4] and teaching hospitals. By requiring life sciences companies to record and report these payments or transfers of value, the Centers for Medicare & Medicaid Services (“CMS”) is striving to promote transparency and reduce the potential for conflicts of interest that HCPs or teaching hospitals might face as a result of their relationships with manufacturers.

Even though PPACA was signed into law in 2010, the final rules pertaining to the Sunshine Act were not finalized until February 2013, at which time CMS announced that companies will be required to begin data capture on August 1, 2013, and submit their first federal reports by March 31, 2014. As a result, the Sunshine Act is having significant financial and operational impact within the life sciences industry. Multi-functional aggregate spend systems, used in part, to track HCP payments across the enterprise, have been or are being implemented at many of the large global companies that dominate the sector. Similarly, small, mid-size and large LSCs are examining the compensation arrangements they have with speakers, consultants, educators, advisory board members and researchers/clinical investigators. Compliance departments throughout the industry are developing policies and procedures for standardizing their relationships with HCPs. There appears to be growing consensus, that in an age of increasing transparency, LSCs will need FMV-compliant compensation plans that are well-defined and applied consistently across the enterprise.

STATE LAWS

Prior to the implementation of the Sunshine Act, a number of state laws were implemented to impose limits and reporting requirements on interactions between HCPs and LSCs. These laws, enacted in Massachusetts,[5] Vermont,[6] California,[7] the District of Columbia,[8] Minnesota,[9] and West Virginia,[10] generally are broader in scope than the federal Sunshine Act. Although the federal Sunshine Act preempts corresponding state law requirements, the future of these state laws remains unknown.

THE WORLDWIDE REGULATORY ENVIRONMENT

In addition to country specific transparency laws (e.g., France and Slovakia) and organizational codes of ethics (Eucomed, PhRMA, IFPMA, EFPIA, etc.), several countries, including the U.S., have developed anti-corruption laws that include significant penalties for non-compliance, even when the violations occur outside of the country’s geographic boundaries (e.g., the U.K. Bribery Act, the U.S Foreign Corrupt Practices Act (“FCPA”)). These laws are particularly important for LSCs, because in many countries, most healthcare professionals are government employees. Thus, nearly every interaction with healthcare professionals may potentially expose a company to criminal and civil liability under applicable anti-corruption laws.

THE FOREIGN CORRUPT PRACTICES ACT (I.E., FCPA)

Enacted as a result of investigations by the Security and Exchange Commission (“SEC”) in the 1970s that led to over 400 U.S. companies admitting to making questionable or illegal payments to foreign governmental officials; the FCPA prohibits U.S. companies from making payments to foreign officials for the purpose of getting or keeping business. The FCPA has dual enforcers –the Department of Justice (“DOJ”) and the SEC.

In the U.S., the DOJ and the SEC have been aggressively enforcing the FCPA against both companies and individuals. Therefore, because so many of the HCPs with whom they interact are employees of foreign governments, .LSCs must exercise vigilance in their interactions with HCPs.

THE U.K. BRIBERY ACT (THE “BRIBERY ACT”)

The Bribery Act, which went into effect in July 2011, imposes criminal liability for a variety of bribery offenses. The unique features of the Bribery Act include that it:

• Applies to all bribery, whether in the public or private sector;
• Applies to both the giving and receiving of bribes; and
• Creates a new corporate offense if a corporation fails to prevent bribery.

Enforcement of the Bribery Act is the responsibility of the Serious Fraud Office (“SFO”).

Arguably, one of the most significant elements of the Bribery Act involves the fact that simply having a presence in the United Kingdom (“UK”), whether a subsidiary, office or just some type of operation, will create jurisdiction. The Bribery Act applies to both UK companies and foreign companies with operations in the UK, even if offenses take place in a third country and are unrelated to UK operations. This means that the relevant criminal act can occur outside the UK and persons or companies in the UK can be liable. For example, if a US company has a UK branch and one of its employees engages in bribery in Asia, the US company may have liability under the Bribery Act and could be prosecuted in the UK for failing to prevent bribery.

The stakes are getting higher and the penalties are becoming more onerous as increasing numbers of countries are implementing transparency laws. Therefore, the life sciences industry has significant incentive to develop and maintain effective operational controls in terms of global interactions with HCPs. One of the most effective and easily implemented strategies to mitigate risk and facilitate compliance with emerging transparency and bribery laws involves the requirement that all compensation paid to HCPs be deemed to be within fair market value. Therefore, the use of an outside independent valuator to determine both the commercial reasonableness (“CR”) and fair market value (“FMV”) of compensation arrangements between HCPs and LSCs provides an effective way to maintain compliance.

It is well beyond the scope of this paper to describe the details of every applicable law and regulation. Notwithstanding, it is important to understand that the regulatory environment is becoming increasingly complex and that expanding transparency requirements may significantly impact the opportunities for prosecution related to bribery offenses.

VALUING HCP COMPENSATION ARRANGEMENTS

When assessing the FMV of compensation within the context of the life sciences industry, it must be understood that compensation earned by a healthcare professional in his or her specialty practice may not be directly comparable to compensation associated with providing speaking, consulting or research services to a LSC. Furthermore, only HCPs who possess the specific expertise and experience required by the LSC will be engaged to provide services. Therefore, the valuation of HCP compensation arrangements within the life sciences industry requires knowledge of three distinct, but interrelated elements (i) the type, level, and extent of the services to be provided; (ii) the skills and experience required of the HCP; and (iii) the amount of time required in order to fulfill the requirements of the position.

HCPs generally provide three categories of services for LSCs:

• Consulting/advisory services;
• Research services; and
• Speaking/education services

For the most part, a specific HCP is engaged by an LSC to perform services because he/she possesses certain expertise and experience that cannot be duplicated by LSC employees. For example, HCPs with extensive clinical practice experience in working with patients with specific diseases or disorders can provide significant value to LSCs in the development and evaluation of products. Furthermore, HCPs tend to pay more attention to what their colleagues have to say about the efficacy of a particular treatment or device than they do to someone with little to no clinical experience.

It is also important to note that required skills and experience vary considerably, depending upon the activity for which the HCP is being engaged. For example, the skills and experience required of an HCP who is engaged to provide consulting services related to basic research in early stage molecule development may be far different than the HCP who is engaged to assist in obtaining regulatory approval for a drug or device. Furthermore, even HCPs engaged in similar clinical activities (e.g., cardiovascular surgeons) can vary widely in terms of experience and expertise. For example, cardiovascular surgeons may range from the local-level practitioner to the internationally acclaimed “thought leader” who has published hundreds of peer reviewed journal articles, held leadership positions in professional societies and spoken at conferences throughout the world. Therefore, the process of quantifying relevant differences in skills and role requirements, and developing an effective and reliable methodology to stratify HCPs into homogeneous groups in order to determine the FMV of compensation, can be quite challenging.

Furthermore, in order to establish the commercial reasonableness (i.e., CR) of the arrangement, the appraiser also needs to consider the time requirements of the position. For example, if an HCP is engaged for 1,500 hours a year, it may be more appropriate to employ him/her rather than engaging him/her as an independent contractor; thereby, questioning the commercial reasonableness of the arrangement.

STRATIFYING HCPS

In determining the FMV of compensation, the valuator typically develops one or more stratification models to classify HCPs into homogeneous groups or tiers (the “Tiers”) based on level of experience, expertise and the unique requirements of the role/activities for which the HCP is being engaged (collectively the “Attributes”). For example, the skills and experience required of the medical researcher engaged by an LSC to perform basic research are typically very different from those required of an orthopedic surgeon who is engaged to provide clinical training in the use of a knee replacement navigation system. Similarly, differences in level of expertise and influence are evident when comparing the expertise of the orthopedic surgeon who uses the navigation system in his/her clinical practice to the nationally renowned orthopedic surgeon who developed key algorithms that form the basis of the navigation system.

Therefore, the Attributes used to stratify HCPs can vary considerably depending on the specific requirements of the position for which the HCP is engaged. Commonly considered stratification Attributes include, but are not limited to:

Educational credentials and specialized training;

• Professional certifications;
• Leadership experience;
• Academic appointments;
• Research experience and funding history;
• Invited presentations on both a national and international level;
• Publication history; and
• Service on editorial boards.

Other attributes, specific to the requirements of the position for which the HCP is engaged, are generally developed through discussions with the LSC and key constituents involved in selecting the HCP. Basic science consulting services, for example, may require very specific skills or expertise, and may not require extensive leadership experience or clinical certifications; whereas, international speaking assignments may require the HCP to have extensive leadership, research and publication experience. The only requirement is that selected Attributes must be operationally defined and be objectively measured. Some examples include, number of years of experience in (i) working with the Food & Drug Administration; (ii) writing research guidelines; (iii) using a particular device in a clinical setting; and/or (iv) treating patients with a particular disease state.

When developing a HCP stratification model, the valuator, together with the LSC, must also consider the appropriate number of Tiers to incorporate into its design. For HCPs based in the U.S., we generally see the use of four-Tier classification models:

• Tier I: International-level
• Tier II: National-level
• Tier III: Regional-level
• Tier IV: Local-level

Each Tier is associated with a different level of compensation. Therefore there are two distinct, but interrelated components required in determining the FMV of HCP compensation (i) development of the stratification model; and (ii) determination of the appropriate/FMV compensation payable at each tier.

Before moving to a discussion on compensation, it is important to note that when developing stratification models for HCPs residing (and being paid) outside of the U.S., the valuator must keep in mind that the primary source of information regarding the experience and expertise of the HCP, the curriculum vitae (“CV”), may not include the same level of information as seen in the CVs of U.S.-based HCPs. Therefore, it would be advisable to review a representative sample of CVs for HCPs in each country to be included in the analysis prior to developing the Attributes and stratification model.

DETERMINING APPROPRIATE COMPENSATION LEVELS

Once the number of stratification Tiers is determined, the valuator will need to determine the FMV compensation rate associated with each Tier. For U.S.-based HCPs, compensation data can be derived from a variety of sources. Notwithstanding, the use of published surveys that include values from multiple health care industry segments (e.g., private clinical practice, hospital-based practice, etc.) may be more accurate in addressing any potential over-compensation bias that, may occur in market comparables obtained solely from similar relationships between healthcare providers and life sciences companies.[11] A partial list of the some of the most widely respected surveys includes the following:

• Medical Group Management Association (“MGMA”), Physician Compensation and Production Survey;
• Sullivan, Cotter and Associates, Inc., Physician Compensation and Productivity Survey Report;
• Hospital & Healthcare Compensation Service, Physician Salary Survey Report;
• Hospital & Healthcare Compensation Service, Hospital Salary & Benefits Report
• American Medical Group Association (“AMGA”), Medical Group Compensation and Financial Survey;
• Towers Watson Data Services (formerly Watson Wyatt), Survey Report on Health Care Clinical & Professional Personnel Compensation;
• MGMA Academic Practice Compensation and Production Survey for Faculty and Management;
• Report on Medical School Faculty Salaries; Association of American Medical Colleges;
• The Medical Director Survey: Integrated Healthcare Strategies (formerly Clark Consulting – Healthcare Group);
• Cejka Search and The American College of Physician Executives, Physician Executive Compensation Survey; and
• MGMA Medical Directorship and On-Call Compensation Survey.

Once the appropriate surveys are selected, the valuator will utilize available benchmark compensation earned by HCPs in their areas of specialty as the basis for determining the FMV of compensation. Valuator judgment and experience play a part in determining the compensation thresholds to be established for each Tier. For example, should the Tier IV or local level compensation threshold be set at the published median or at a different level? Similarly, is it appropriate to establish the Tier I or international level compensation at the 90th percentile level, or would it be more appropriate to recognize that the internationally recognized HCP is probably compensated at a rate higher than the 90th percentile?[12]

Regardless of the surveys considered or the thresholds set at each Tier, compensation data based on the identified specialty should be used in the analysis. For example, when determining the FMV compensation for a nephrologist, survey data relating to nephrology compensation should be used as a benchmark within the analysis. Similarly, when determining the FMV compensation for medical physicists, the valuator will need to utilize benchmark survey data for medical physicists with the same qualification as the HCP(s) to be engaged. Therefore, if the LSC is intending to engage the services of Ph.D. physicists who are certified, then it would be inappropriate to utilize benchmark compensation data for master’s degree physicists who are not certified.

The life sciences industry is dealing with a series of global challenges relating to increasing competition, escalating costs and expanding regulatory requirements. New regulations, focusing on requirements for transparent interactions between life sciences companies (“LSCs”), physicians and other types of healthcare providers (e.g., pharmacists, basic science researchers, physicists, etc., and together with physicians, the “Healthcare Providers” or “HCPs”), are being implemented by governments and industry associations throughout the world. Anti-corruption laws (e.g., The Foreign Corrupt Practices Act[1] in the U.S. and the U.K. Bribery Act[2]), which provide criminal penalties for violations, are now more easily enforced with the implementation of the new transparency requirements.

RELATIONSHIPS BETWEEN HEALTHCARE PROFESSIONALS AND LIFE SCIENCES COMPANIES

When determining the FMV of compensation arrangements between HCPs and LCS within the U.S., benchmark data can be obtained from a broad variety of specialized data sources in addition to the general surveys identified above. For example, the American Dental Association and the American Association of Physicists in Medicine publish extensive compensation surveys. However, when determining the FMV compensation rate for HCPs residing and working outside of the U.S., non-tainted sources of comparable compensation data become much more difficult to obtain. Furthermore, it is important for the valuator to understand the HCP compensation structure in each of the countries considered. For example:

• Are all the physicians employed?
• Are only physician specialists employed?
• Do employed physicians also maintain independent private practices?

In most cases, benchmark compensation data for specific clinical specialties will not be available in many countries outside of the U.S. Rather, governments and NGOs generally report physician compensation based on just two categories, generalists and specialists. Furthermore, data may only be reported every few years, making meaningful comparisons to current rates quite difficult. Accordingly, it is important to adjust compensation benchmarks to account for changes in the price level of the subject country. This adjustment is especially important for countries that have experienced significant changes in price level in recent years (e.g., the inflation rate in Vietnam in 2011 totaled 18.7%). To the extent possible, it is advisable to apply CPI adjustments reported for healthcare expenditures, as this statistic is commonly tracked by national statistical agencies. Due to the varying ways healthcare systems are run among different countries, the application of a healthcare-specific CPI adjustment may mitigate the risk of inaccuracies in the compensation calculations for HCPs residing and working outside of the U.S.

IN CONCLUSION

Changes in the regulatory landscape within the U.S. and throughout the world are having a profound impact in the way LSCs are doing business. Anti-bribery and transparency laws are having a significant impact on compensation arrangements between LSCs and HCPs. Ensuring that compensation arrangements with HCPs are within FMV is an effective and easily implemented way to ensure compliance. In order to be effective, the methodology used to determine the FMV of HCP compensation arrangements must be objective and applied consistently. The valuation of HCP compensation arrangements generally requires knowledge of three interrelated elements (i) the type, level, and extent of the services to be provided; (ii) the skills and experience required of the HCP; and (iii) the amount of time required in order to fulfill the requirements of the position. This information will facilitate the development of a stratification model to establish homogeneous compensation categories (i.e., Tiers). Once developed, the stratification model will provide an objective and repeatable mechanism to evaluate an HCP’s CV to determine the appropriate level of compensation. Since the availability of benchmark compensation data, as well as the level of information included in a typical CV, varies widely among countries, in order to provide FMV compensation rates for HCPs outside of the U.S., the valuator must have a good understanding of (i) the regulatory environment in each country; (ii) how HCPs are compensated; (ii) valid data sources; (iii) CPI adjustment mechanisms; and (iv) currency conversion requirements.