Seizing Control

John Steinmann, D.O., an orthopedic surgeon with Arrowhead Orthopaedic Medical Group in Redlands, California, didn’t just complain about the rising costs of implants, he did something about it. He took his own means of production into his hands. Workers Unite!!!

Steinmann and his colleagues, Drs. Gail Hopkins, Paul Burton and John Skubic decided to cut out the middleman in the value chain of medical devices from manufacturer to patients.

“Cutting the Fat”

Citing escalating implant prices, decreasing reimbursements for physicians, and declining hospital profits, the band of physician brothers and sister decided to, as Steinmann recently told OTW, “cut the fat” and start their own physician-owned distribution company (POD).

Each surgeon owner invested personal capital to fund the purchase of joint replacement and spinal implant inventory and to fund company operations. The company then hired staff with medical and orthopedic experience to support standard distribution functions and provide these distribution services to three local hospitals.

Their distributorship performs the following functions:

• Identifies/selects preferred implants
• Negotiates inventory purchase
• Manages inventory
• Employs product representatives
• Delivers implants/instruments
• Provides technical support
• Provides billing and collections

Depending upon where you sit in this value chain, your stand on whether this is legal and ethical will be dramatically different.

Steinmann’s distribution company, Inland Spine and Orthopedics, buys implants in bulk directly from manufacturers, warehouses them, and then sells them to hospitals. The company then delivers the implants to the hospitals where Steinmann may well end up implanting that same device in a patient.

Legal, Ethical?

Steinmann and his colleagues addressed legal and ethical issues before opening their doors. They went to one of the largest healthcare law firms in the country and were given the green light. Lawyers who represent device companies begged to differ. The hospitals that became customers of the POD also went through their own extensive legal review and decided they could buy Steinmann’s implants. Oh, they were also happy to save over 30% over prices from traditional distributors.

John Steinmann, D.O.Steinmann told OTW that there is a big problem when the decision makers over which device to use, are not the purchaser and there is an absence of effective price negotiation and price control. And, quite frankly, he thinks distributors and products reps are overpaid.

Inland’s lawyers at Hooper, Lundy and Bookman issued an opinion that the sale of medical devices to a POD, and sales of those devices by the POD to hospitals, “should not be found to be prohibited by federal anti-kickback or self-referral or by California similar laws.”

Furthermore, “With respect to federal Stark law, we conclude that the exception for indirect remuneration (41 C.F.R. Section 411.357 (p) will be available.”

Steinmann says the model was also cleared by the legal departments of Catholic Healthcare West, Arrowhead Regional Medical Center, Redlands Community Hospital, Avista, Exempla Lutheran and the Gerald Champion Regional Medical center.

Hogan & Hartson: “An Obvious and Unavoidable Potential for Abuse”

The Catholics and Lutherans may have agreed, but the lawyers at Hogan & Hartson, who represent some in the distributor supply chain, did not.

The firm said it issued a paper “in response to information gathered from various firm clients and others regarding the growing—and we believe improper—influence of physician-owned intermediaries in the medical device industry.”

The Hogan paper says, on close examination, PODs,

essentially are shell entities, with no real infrastructure or capital investment, that exist for the unlawful purpose of directing remuneration to physicians for their ability to control the selection of surgical implants sold through the scheme.” The paper continues that, unlike “legitimate distributors and Group Purchasing Organizations, PODs present an obvious and unavoidable potential for the patient and program abuses that the federal antikickback statute was specifically intended to prohibit.

An “obvious and unavoidable potential” is a line Jon Stewart would have fun with on the Comedy Channel and is a phrase only lawyers can come up with that means nothing and everything at the same time.

Real Risk

Steinmann says there is a “real infrastructure” and “capital investment” in their distributorship. The company has to buy and warehouse enough inventory to assure that implants are available to the hospitals when they are needed. The physicians take on all the financial risk up front, says Steinmann. In addition there are no guarantees of percent of sales and no direct hospital contracting

The distributorship, according to Steinmann, sells membership interests at fair market value without concern for volume or value of referrals and distributes profits based on investment interest

By the Numbers

What are the financial outcomes of such an enterprise?

The surgeons presented a scientific exhibit (SE48) at the American Academy of Orthopaedic Surgeons’ 2009 meeting to demonstrate the financial outcomes.

Their retrospective study reviewed all cases in which the distribution company was the implant supplier and compared those implant costs with the average contract cost (not list price) of like implants purchased by three hospitals during the same time period. All implant systems used and compared in the study were FDA-cleared products from U.S. companies.

The implant systems included:

• Fixed bearing, tricompartmental knee replacements
• Metal on highly crosslinked poly, tapered stem, total hip replacement
• Anterior cervical plate system
• Titanium polyaxial pedicle screw system

From May 2006 through May 2008, the surgeon-owned company distributed implants for 544 cases:

• 155 primary total knees replacements
• 62 primary total hip replacements
• 199 posterior lumbar instrumentations
• 128 anterior cervical instrumentations.

Each hospital reported the average contracted price for these implant systems. Surgeon-owned distributor prices were not included in calculating the average contracted price, and were reported separately.

Thirty-Four Percent Savings

The total cost of implants sold by the surgeon-owned distributorship during the study period was $2, 058, 217. The total cost of purchasing the equivalent implants using the hospitals average contract price during the study period would have been $3, 099, 192. Hospital savings resulting from purchasing implants from Inland was $1, 040, 974 representing a 34% savings.

Irresistible Future Model

The Hogan paper says the financial appeal of this business model is “proving irresistible to a growing number of physicians, ” and, “may eventually become the dominant players in choosing medical devices.” That should get physicians’ attention.

Steinmann says Inland’s prices have not increased since 2006 and in 2010 announced a price reduction.

No wonder Hogan thinks this will be a model for the future.

Ethics

Is it ethical?

The Hogan paper says PODs create a conflict of interest that, “can distort medical decision making because it gives physicians an incentive to order the implants that will benefit them financially, rather than to choose the products that are best for their patients.” The paper points out that the trigger for anti-kickback laws rests on intent.

Steinmann says that depends on the actions of the individual using the model. “Providing you intend to act ethically—it’s ethical, ” he says.

He says PODs only distribute products that meet or exceed the quality of products currently being used by the surgeon and they provide complete disclosure to their patients.

“It must be transparent and demonstrate merit through cost savings, ” added Steinmann.

Continued Steinmann,

While it is important to insure profitability for implant manufacturers to insure continued product innovation and support, the costs of implant sales, marketing and distribution, on the other hand, adds questionable value when considering the expense associated with these functions.

Whether or not PODs are legal and ethical may still be up in the air. They are legal until a judge rules they are illegal or a payer such as Medicare stops paying and that has not happened.

In fact, in 2006, California’s Attorney General issued an official opinion that said a physician, “generally may prescribe for a patient a medical device that is distributed by a company in which the physician has an ownership interest, provided that any return on investment is based upon the physician’s proportional ownership share and requisite disclosures are made.”

OIG: Close Scrutiny Required

We’ll give the Hogan paper the last word on where this is heading.

“In October 2006, the Office of Inspector General of the Department of Health and Human Services (OIG) indicated it was ‘aware of an apparent proliferation’ of PODs and stated, ‘[g]iven the strong potential for improper inducements between and among physician investors, the entities, device vendors, and device purchasers, ’ the OIG believed ‘these ventures should be closely scrutinized under the fraud and abuse laws.’”

Those whose livelihood is being threatened by this distribution model have every right to demand the highest level of scrutiny. Ultimately, what is in the best interest of patients must rule the day.